Selling naked puts is a great way to purchase shares in companies you like at a predetermined price. In essence, you are getting paid to put in a "limit order."
An investor usually sells a put option if his/her outlook on the underlying security is bullish. The buyer of the put option pays the seller a premium for the right to sell the shares at an agreed-upon price. If the stock does not trade at or below the agreed-upon price (strike price), the seller gets to keep the premium.
Benefits associated with selling naked puts
- In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
- It allows one to generate income in a neutral or rising market.
- When you sell a naked put you are in a way acting like an insurance agent. The seller of the option agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, you (the seller) are paid a premium upfront. If this strategy is repeated over and over again these premiums can really help boost your returns over time.
- Acquiring stocks via short puts is a widely used strategy by many retail traders and is considered to be one of the most conservative option strategies. This strategy is very similar to the covered call strategy.
- The safest option is to make sure the put is "cash secured." This simply means that you have enough cash in the account to purchase that specific stock if it trades below the strike price. Your final price would be a tad bit lower when you add the premium you were paid up front into the equation. For example, if you sold a put at a strike of 20 with two months of time left on it for $2.50; $250 per contract would be deposited in your account.
- Most put options expire worthless and time is on your side. Every day you profit via time decay as long as the stock price does not drop significantly. In the event it does drop below the strike you sold the put at, you get to buy a stock you like at the price you wanted. Time decay is the greatest in the front month.
The majority of traders opt to close the put out prior to expiration if they have the chance of buying it back at much lower price. For example, selling the put at $2.50 and buying it back at $0.50.
Warning
This strategy should not be employed on speculative stocks. This strategy should only be employed if you would like to own the stock but want to purchase it at a lower price.
Reasons to be bullish on Halliburton (HAL):
- A strong levered free cash flow of $785 million.
- Net income surged from $1.14 billion in 2009 to $2.83 billion in 2011.
- Cash flow per share jumped from $2.38 in 2009 t0 $4.84 in 2011.
- Annual EPS before NRI increased from $2.66 in 2007 to $3.36 in 2011.
- It has a very low payout ratio of 11%.
- A great retention ratio of 89, which provides it with ample cash flow to expand via organic growth programs or through acquisitions.
- 5 year sales growth rate of 5.53%.
- Sales increased from $1.4 billion in 2009 to $2.4 billion in 2011.
- A very good long-term debt to equity ratio of 0.35.
- A good quarterly earnings growth rate of 22%.
- A good current and quick ratio of 2.89 and 2.19, respectively.
- A splendid interest coverage ratio of 17.6.
- A great quarterly revenue growth rate of 30%.
- Percentage held by institutions is 76%.
- A high beta of 1.70 makes it a good candidate for covered writes, and for selling puts.
- A five ROE average of 26%.
- A projected 3-5 year EPS growth rate of 13%.
- Year over year projected growth rates of 5% and 12.7% for 2012 and 2013 respectively.
- 100K invested for 10 years without reinvesting the dividends would have grown to $354K.
Suggested Put strategy for Halliburton
It has still not managed to break its downtrend despite being a corrective phase for almost a year. A weekly close below 30 could result in a test of its Oct 2011 lows (27.21). Once it closes below 30 the only strong support it has in the 23-24 ranges. Investors can wait for a test of the 27.21 ranges and then sell naked puts in the 25-27 ranges.
It is now trading at $29.31, and the Oct 27 2012 puts are trading in the 1.99-2.03 ranges. So roughly when it trades down to the 27.00 ranges, the Oct 25 puts should be trading roughly in the same range. As long as it does not take an inordinate of time to get there, and if it does traders can aim for the Jan 2013 puts to try to lock in a similar premium. For this example, let us assume that we can sell the Oct 25 puts for $1.99. For each contract sold, $199 will be deposited in your account. If the stock trades below 25, then the shares could be assigned to your account. Your final price would be 23.01 (25-1.99). If the stock does not trade below 25, you get to keep the premium and walk away with a gain of roughly 8% in five months.
A more extreme strategy would be to wait for it to test 24 and then sell puts with strikes in the 22-24 ranges. As this is a more extreme entry - your chances are also much slimmer of getting a fill here. However, you could split your money into 2-3 lots and deploy the second lot on a test of 24.00. With this strategy, you could end up getting in as low as $20, which would make for a remarkable long term entry in our opinion. You should understand though that the odds are not very high that it will trade this low. With the wild way, the markets move today, though one never knows, and it will hurt to place a second order at this level.
Company: Halliburton Co
Levered free cash flow = $785 million
Basic Key ratios
- Short percentage of float= 2.5%
- Relative Strength 52 weeks = 30
- Cash Flow 5-year Average = 3.29
- Dividend Yield 5-Year Average = 1.16
Growth
- Net Income ($mil) 12/2011 = 2839
- Net Income ($mil) 12/2010 = 1835
- Net Income ($mil) 12/2009 = 1145
- Net Income Reported Quarterly ($mil) = 627
- EBITDA ($mil) 12/2011 = 6071
- EBITDA ($mil) 12/2010 = 4071
- EBITDA ($mil) 12/2009 = 2898
- Cash Flow ($/share) 12/2011 = 4.84
- Cash Flow ($/share) 12/2010 = 3.3
- Cash Flow ($/share) 12/2009 = 2.38
- Sales ($mil) 12/2011 = 24829
- Sales ($mil) 12/2010 = 17973
- Sales ($mil) 12/2009 = 14675
- Annual EPS before NRI 12/2007 = 2.66
- Annual EPS before NRI 12/2008 = 2.94
- Annual EPS before NRI 12/2009 = 1.35
- Annual EPS before NRI 12/2010 = 2.06
- Annual EPS before NRI 12/2011 = 3.36
Dividend history
- Dividend Yield = 1.2
- Dividend Yield 5 Year Average 12/2011 = 1.16
- Annual Dividend 12/2011 = 0.36
Dividend sustainability
- Payout Ratio 09/2011 = 0.11
- Payout Ratio 5 Year Average 12/2011 = 0.16
Performance
- Next 3-5 Year Estimate EPS Growth rate = 13
- 5 Year History EPS Growth 12/2011 = 0.96
- ROE 5 Year Average 12/2011 = 26.22
- Current Ratio 12/2011 = 2.79
- Current Ratio 5 Year Average = 3.1
- Quick Ratio = 2.19
- Cash Ratio = 0.95
- Interest Coverage = 17.6
Conclusion
The markets are still in a corrective mode, but in the interim, some sort of relief rally could (key word being could) take hold as they are extremely oversold. Long-term investors can use strong pullbacks to slowly start deploying money into long-term investments. A great way to get into a stock at a price of your choosing is to sell puts at strikes you would not mind owning the stock at.
Disclaimer
This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: EPS and Price vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Earnings estimates and growth rates data sourced from dailyfinance.com. Data for Ycharts sourced from ycharts.com. Options table data sourced from yahoofinance.com.
