Selling 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 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 you 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
Some Reasons to be bullish on Alpha Natural resources (ANR):
- Quarterly revenue growth rate of 71%
- Positive levered free cash flow of 454 million
- A strong institutional presence; Percentage held by Institutions = 79%
- EBITDA increased from $526 million in 2009 to $899 million in 2011
- Cash flow per share increased from $4.91 in 2009 to $8.01 in 2011
- Sales surged from $2.4 billion in 2009 to $7.10 billion in 2011
- A five-year ROE of 12.81
- A 5 year historic EPS growth rate of 23.9
- A current ratio of 1.47 and a quick ratio of 1.13
- A projected3-5 year EPS growth rate of 5%
- A five-year sales growth rate of 30%
- A long-term debt to equity ratio of 0.39
- A free cash flow yield of 5.06%
Suggested put Strategy for Alpha Natural resources
It has broken all levels of support as indicated above in the 10 year chart. Thus at this stage one should aim for an entry point that would have not been imaginable a few months ago. It currently trading at 8.67 and given that it has shown no signs of putting in a bottom, there is a decent chance it could experience one more wave of selling pressure that could push down to the 5.50-6.00 ranges.
The Jan 2014, 5 puts are trading in the 1.06-1.10 ranges. If the stock dropped down to the suggested ranges, these puts should move up by 1.25-1.50. For this example we will assume that the puts can be sold for 2.31 (current price of 1.06 plus 1.25) if the stock pulls back to the suggested ranges. For each contract sold, $231 will be deposited into your account.
If the stock trades below the strike price, the shares could be assigned to your account.
If the stock is assigned to your account you will get in at much better price then buying the shares outright at this point in time. Your final price per share would be $2.69 which could prove to be an incredible long term entry point. On the other hand, if the shares are not assigned to your account you get to walk away with a fat premium. In this case the premium works out to a gain of 46.2%
The coal sector has taken a beating and from a contrarian perspective makes for a great play as it is detested and is being ignored by most investors. One now has the chance to get into many of these plays at the levels they were trading back in 2002-2003 before they broke out. Coal is a cyclical commodity, when it corrects the stocks take a severe beating and when coal prices start to rise, the stocks in that sector usually soar in value. Investors willing to take a risk could potentially score a home run here. However, remember this is a speculative play, and if you are not up to taking on some risk, you would be best served by looking at other plays.
Disclaimer: This 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. 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. Options tables sourced from money.msn.com. Ycharts data sourced from ycharts.com.