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. It allows one to generate income in a neutral or rising market.
2. 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.
3. 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.
4. 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 like Enterprise Products (NYSE:EPD):
- Net income increased from $204 million in 2009 to $2.04 billion in 2011.
- A good yield of 5.30%
- Cash flow per share increased from $3.15 in 2009 to $3.34 in 2011.
- Annual EPS before NRI increased from $0.96 in 2007 to $2.21 in 2011.
- Sales Vs 1 year ago increased by 31%
- A five-year cash flow average of $2.37
- A five dividend growth rate of 5.73%
- A five-year sales growth rate of almost 25%
- Year over year projected growth rates of 14.24% and 7.32% for 2012 and 2013 respectively.
- Quarterly revenue growth rate of 10.5%
- A strong quarterly earnings growth rate of 54.8%
- Insiders have a 34.7% stake in the company.
- A strong relative strength score of 85 out of a possible 100
- A good five-year average yield of 6.8%
- $100K invested for 10 years would have grown to $340K
Suggested Put Strategy for Enterprise Products
We would wait for a re test of the 45.60-46.00 ranges before putting this strategy into play as the stock is still attempting to put in a bottom.
The Jan 2013, 45 puts are trading in the 2.05-2.20 ranges. If the stock pulls back to the stated ranges, these puts should rise in value by roughly 1.25-1.50. For this example, we will assume that if the stock pulls back to the suggested ranges the Puts can be sold for 3.30. For each contract sold, $330 will be deposited into your account.
Advantages of using this strategy
If the stock trades below the strike price, the shares could be assigned to your account. Your final price in this case would be 41.70 (45.00-3.30). If the stock does not trade below 45.00, then you get to walk away with the premium for a gain of 7.1% in roughly seven months. Also, there is nothing to stop you from implementing this strategy again and again.
If the stock trades below the strike price, the shares could be assigned to your account, but as you were bullish to begin with, this should not be a big issue.
Important facts investors should be aware in regards to investing in MLPs
Payout ratios are not that important when it comes to MLPS generally pay a majority of their cash flow as distributions. Payout ratios are calculated by dividing the dividend/distribution rate by the net income per share, and this is why the payout ratio for MLPs is often higher than 100%. The more important ratio to focus on is the cash flow per unit. If one focuses on the cash flow per unit, one will see that in most cases, it exceeds the distribution declared per unit.
MLPs are not taxed like regular corporations because they pay out a large portion of their income to partners (as an investor you are basically a partner and are allocated units instead of shares) usually through quarterly distributions. The burden is thus shifted to the partners who are taxed at their ordinary income rates. As ordinary income tax rates of investors are typically lower than the income tax assessed on corporations, this arrangement is advantageous to the MLPs and generally most investors.
MLPs issue a Schedule K-1 to their investors. Unrelated business income (UBI) above $1,000 is taxable in an IRA. This information will appear Box 20 in the schedule K-1. UBI is typically a very small number usually well below $1000 and in some cases negative. If the MLP pays out distributions in excess of the income it generates, the distribution is classified as a "return of capital" and tax deferred until you sell your units. For more information, on this topic investors can visit the National Association of Publicly Traded Partnerships.
Company: Enterprise Products
Basic Key ratios
1. Relative Strength 52 weeks = 85
2. Cash Flow 5-year Average = 2.37
1. Net Income ($mil) 12/2011 = 2047
2. Net Income ($mil) 12/2010 = 321
3. Net Income ($mil) 12/2009 = 204
4. Net Income Reported Quarterly ($mil) = 651
5. EBITDA ($mil) 12/2011 = 3867
6. EBITDA ($mil) 12/2010 = 3137
7. EBITDA ($mil) 12/2009 = 2690
8. Cash Flow ($/share) 12/2011 = 3.34
9. Cash Flow ($/share) 12/2010 = 1.63
10. Cash Flow ($/share) 12/2009 = 3.15
11. Sales ($mil) 12/2011 = 44313
12. Sales ($mil) 12/2010 = 33739
13. Sales ($mil) 12/2009 = 25511
14. Annual EPS before NRI 12/2007 = 0.96
15. Annual EPS before NRI 12/2008 = 1.85
16. Annual EPS before NRI 12/2009 = 1.81
17. Annual EPS before NRI 12/2010 = 1.39
18. Annual EPS before NRI 12/2011 = 2.21
1. Dividend Yield = 5.30
2. Dividend Yield 5 Year Average = 6.8
3. Dividend 5 year Growth = 5.57
1. Payout Ratio = 0.93
2. Payout Ratio 5 Year Average = 1.32
1. Next 3-5 Year Estimate EPS Growth rate = 6.4
2. 5 Year History EPS Growth = 15.17
3. ROE 5 Year Average = 12.81
4. Current Ratio = 0.80
5. Current Ratio 5 Year Average = 0.93
6. Quick Ratio = 0.60
7. Cash Ratio = 0.06
8. Interest Coverage Quarterly = 4.00
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 this article to be of interest: Seadrill Ltd: Time To Take A Closer Look At This High dividend play.
Sources: 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.
Disclaimer: 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.