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.
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."
Benefits associated with selling puts
- It allows one to generate income in a neutral or rising market.
- 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.
Some Reasons to be bullish on Seadrill (NYSE:SDRL):
- A great yield of 9.5%
- EBITDA increased from $2.05 billion in 2009 to $2.3 billion in 2011.
- A decent inters ratio of 4.9.
- Net income increased from $1.26 billion in 2009 to $1.48 billion in 2011.
- It has a high beta which makes it a good candidate for covered writes, or you can also sell puts if you are bullish on the stock.
- Cash flow increased from $3.95 in 2010 to $4.22 in 2011.
- Sales increased from $3.2 billion in 2009 to $4.19 billion in 2011.
- Year over year projected growth rates of 11.3% and 8.89% for 2012 and 2013 respectively.
- Annual EPS before NRI increased from $2.60 in 2009 to $2.90 in 2011.
- It has a projected 3-5 EPS growth rate of 48%
- A total three year return of 180%
First quarter 2012 highlights
- It reported Net income of $439 million and earnings of $0.89 per share. If this rate is maintained, net income could soar well past the 1.75 billion mark for 2012.
- It increased the quarterly cash dividend by 2 cents to $0.82. A onetime dividend of 15 cents per share will be paid related to cash distribution from its investment in Sapuracrest.
- It secured additional new contracts with a projected revenue potential of $870 million
- It ordered two ultra deep water harsh environment semi submersible rigs for a total cost of $1.3 billion.
- It secured a 3 year contract for the ultra deepwater semi-submersible rig West Leo with the potential to generate an additional $710 million in revenue.
- It secured a 5 year contract for the tender rig T 18 with a revenue potential of $235 million
Suggested Put Strategy for Seadrill
The markets are still in a corrective phase and could test their lows again. Additionally this is also a very volatile stack with a high beta of 1.99. Consider waiting for a test of the 30.50-31.50 ranges before putting this strategy into play.
The Jan 2013, 29.65 puts are trading in the 2.45-2.60 ranges. If the stock pulls back to the stated ranges, these puts should rise in value by 1.50 or more. For this example, we will assume that the puts can be sold for $3.95. For each contract sold, $395 will be deposited to your account.
The benefits from this strategy are that you either get the shares at a lower price, or you get paid to wait. If the shares are assigned to your account, your final entry price will be $25.70. If the shares do not trade below the strike price, you get to walk away with the premium for a gain of 13.3% in roughly seven months.
The risk factor is that the stock could be assigned to your account, but as you were bullish on this stock to begin with this should not be a big issue.
However, let's assume the stock starts to pull back, and you have a change of heart. For this example let's say the stock has pulled back to 26.20. Your breakeven point is $25.70. You can purchase the puts you sold back and sell new puts with different strikes and pocket the difference. Let say the puts you sold rise in value from $3.90 to $5.00. Your loss is now roughly $1.10 or $110 per contract. You purchase these puts back and then sell the Jan 2013 22.35 puts which at that point should be trading roughly where the Jan 2013, 29.65 puts are currently trading at. As you only need to recoup $110, anything above this is profit. You could also sell puts with more time on them if you are looking for an even higher premium.
You should be bullish on the long term prospects of this stock before you consider putting this strategy to use. This is a volatile stock so you need to be prepared for price swings in both directions. Investors looking for other ideas might find this article to be of interest Reasons To Be Bullish On Kodiak Oil & Gas
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
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. Options tables sourced from money.msn.com. Earnings and growth estimates sourced from dailyfinance.com