One of the strategies I am using more and more as we head into a volatile summer is selling slightly out of money puts on stocks I like at current levels, have low valuations and should at the very least hold their current prices. I think this strategy is likely to outperform the market in the coming months as we work out the structural problems in Europe. One stock in the gaming sector, Activision (NASDAQ:ATVI) continues to outperform its main rival Electronic Arts (NASDAQ:EA) (See chart). Despite this, Activision continues to sport a lower PE and better operating margins than EA and offers a dividend as well. It is a stock I have used this strategy on a couple of times successfully over the last twelve months.
Option Strategy: Sell the January 2013 11 puts on ATVI for $.80.
Outcome 1: Activision stays above $11 at the expiration of the option on January 19th and the investor picks up the 80 cent for an effective annual return of 12% with a decent margin of safety.
Outcome 2: ATVI dips below $11 and the stock gets "put" to the investor for a cost adjusted $10.20 ($11 - $.80).
4 reasons ATVI should stay above $11 a share:
- It has a cash rich balance sheet (around $3.5B in overall) and has over 25% of its market capitalization in net cash. It provides a 1.5% dividend yield as well.
- Consensus estimates for both FY2012 and FY2013 have gone up over the past three months despite the market swoon. In addition, investors should start to anticipate the rollout of new gaming consoles near Christmas 2013 by the time the options expire.
- The stock is selling at the very bottom of its five year valuation range based on P/E, P/B, P/S and P/CF.
- ATVI has a forward PE of under 11 (8 if you take out cash), a steep discount to its five year average (19.1).
Disclosure: I am long ATVI.