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
1. In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
2. It allows one to generate income in a neutral or rising market.
3. 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.
4. 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.
5. 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.
6. 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.
Reasons to Be bullish on Duke Energy (DUK):
- While the rest of the market was correcting this stock was soaring to new highs.
- A decent yield of 4.3%.
- A strong relative strength score of 82 out of a possible 100.
- A five-year dividend average of 5.3%.
- Net income increased from $1.07 billion in 2009 to $1.7 billion in 2011.
- Profit margins of 10%.
- Operating margins of 22%.
- A low beta of 0.34 indicates that it's not a volatile stock.
- Cash flow increased from $2.68 in 2009 to $2.98 in 2011.
- Annual EPS before NRI increased from $1.25 in 2007 to $1.46 in 2011.
- A decent interest coverage ratio of 3.5.
- A projected three- to five-year EPS growth rate of 4.3%.
- $100,000 invested for 10 years would have grown to $161,000. If the dividends were reinvested the rate of return would have been much higher.
- A good free cash flow yield of 6.34%.
- Its merger with progress Energy, Inc., is expected to be a good fit and add boost earnings. The combined assets of the two companies would make it the largest U.S. utility providing services to more than 7.1 million customers. The merger is expected to go through by July 8, 2012, and would enable the company to maintain its long-term goal of 4.5%-6% earnings growth.
- It has a strong balance with a low long-term debt to capitalization ratio of 44% at the end of fiscal 2011. It closed 2011 with a cash and cash equivalents of $2.1 billion.
Suggested Put Strategy for Duke Energy
The stock has put in a series of new 52-week highs, so it's ripe for a consolidation. Consider waiting for a test of the 21.50-22.00 ranges before committing new funds.
The January 2014 22 puts are trading in the 1.85-1.95 ranges. If the stock pulls back to the 21.50-22.00 ranges, these puts should roughly tack on 50 cents more. For this example we will assume that the puts can be sold at $2.35. For each contract, $235 will be deposited into your account.
Advantages of This Strategy
You have the chance to get into the stock at a much lower price. In this case if the shares were assigned to you, your final price would be 19.65 (22.00 minus 2.35). On the other hand if the shares are not assigned to your account you get to walk away with a gain of 10.68%. This more than double Duke Energy's annual current yield of 4.3%.
Risks Associated With This Strategy
The only risk is that the stock trades below the strike price and the shares are assigned to your account. As you were bullish on the stock to begin with, this should not be a big factor.
Company: Duke Energy
1. Beta = 0.34 (very low beta)
2. Long-term debt to equity = 0.84
3. Relative Strength 52 weeks = 84
4. Short percentage of float = 5.9%
5. Quarterly revenue growth rate = -0.9%
6. Quarterly earnings growth rate = -42%
7. Cash Flow Five-year Average = 2.85
1. Net Income ($mil) 12/2011 = 1706
2. Net Income ($mil) 12/2010 = 1320
3. Net Income ($mil) 12/2009 = 1075
4. Net Income Reported Quarterly ($mil) = 295
5. EBITDA ($mil) 12/2011 = 5350
6. EBITDA ($mil) 12/2010 = 5044
7. EBITDA ($mil) 12/2009 = 4428
8. Cash Flow ($/share) 12/2011 = 2.98
9. Cash Flow ($/share) 12/2010 = 2.93
10. Cash Flow ($/share) 12/2009 = 2.63
11. Sales ($mil) 12/2011 = 14529
12. Sales ($mil) 12/2010 = 14272
13. Sales ($mil) 12/2009 = 12731
14. Annual EPS before NRI 12/2007 = 1.25
15. Annual EPS before NRI 12/2008 = 1.21
16. Annual EPS before NRI 12/2009 = 1.22
17. Annual EPS before NRI 12/2010 = 1.43
18. Annual EPS before NRI 12/2011 = 1.46
1. Dividend Yield = 4.30%
2. Dividend Yield Five-Year Average = 5.37
3. Dividend Five-Year Growth = - 0.23
1. Payout Ratio = 0.89
2. Payout Ratio Five-Year Average = 0.7
3. Change in Payout Ratio = -0.01
1. Next Three- to Five-Year Estimate EPS Growth rate = 4.67
2. Five-Year History EPS Growth = 2.08
3. ROE Five-Year Average = 8.53
4. Current Ratio = 1.38
5. Current Ratio Five-Year Average = 1.26
6. Quick Ratio = 0.96
7. Cash Ratio = 0.61
8. Interest Coverage = 3.5
The markets are still very volatile and a normal healthy correction usually ends off with a retest of the recent lows. Thus, there is a decent chance that the markets could pull back and test their lows before mounting a stronger rally. In general, 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. Investors looking for other ideas might find the following article to be of interest: "Nokia Bulls: Significantly Leverage Your Position For Free."
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies -- let the buyer beware.
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.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.