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.
- 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 Deere & Co (DE):
- A good 5 year dividend growth rate of 13.3%
- Cash flow per share increased from $5.6 in 2009 to $8.98 in 2011
- Sales increased from $23.1 billion in 2009 to $32.01 billion in 2011
- Annual EPS before NRI increased from $4.01 in 2007 to $6.63 in 2011
- A good institutional presence; percentage held by institutions is 65%
- A low payout ratio of 23%
- A great retention rate of 77%
- Net income has increased from $874 million in 2009 to $2.8 billion in 2011
- A good current and quick ratio of 2.03 and 1.8 respectively
- A quarterly revenue growth rate of 12.2%
- A quarterly earnings growth rate of 16.8%
- A 3-5 year estimated EPS growth rate of 12.06%
- A five year ROE average of 28.4%
- Year over year projected growth rates of 24% for 2012
- A free cash flow yield of 3.4%
- A good interest coverage ratio of 6.4
- A five year sales growth rate of 7%
- $100K invested for 10 years would have grown to $366K. If the dividends were reinvested the rate of return would be much higher
Suggested Put Strategy for Deere & Co
Sometimes one has to be patient when it comes to selling puts, especially if one is trying to sell puts only when the stock trades down to a specific price range. There are times when a stock will not pull back and just continue trending upwards. Do not worry about this and just move on as there are plenty of great stocks that are worth acquiring. This stock could re test its recent lows again and we would wait for it to pull back to the 72 ranges before putting this strategy to use.
The Jan 2013, 72.50 puts are trading in the 4.70-4.80 ranges. If the stock pulls back to the stated ranges these puts should be trading around the same levels as the Jan 2013 77.50 puts. For this example, we will assume these puts can be sold for $6.70 if the stock sheds $5.99 and drops from 77.99 to 72.00. For each contract sold $670 will be deposited into your account.
Advantages of this strategy
If the stock trades below the strike price you get a chance to get into this stock at a really great price as the shares could be assigned to your account. If the shares are assigned to your account, your final cost per share will be 65.80. If the shares are not assigned to your account, you get to walk away with a gain of 9.24% in roughly 7 months.
There is no real risk factor here as you were bullish from the onset and were prepared for the possibility that the shares could be assigned to your account. The only risk factor is that you have a change of heart along the way. For example, the stock is now trading below the strike price you sold the puts at and you feel the stock could trend even lower. Remember your breakeven point is 65.80. If you do have a change of heart you can always roll the put. In other words, buy the current put back and sell another one at a slightly lower strike.
Selling puts is a great way to get into a stock you like at a price of your choosing. If the shares are not assigned to your account, you get to keep the premium, which in this translates into a gain of 9.24% in seven months. Only put this strategy to use if you are bullish on the stock. If your outlook is not bullish, then you would be better off looking for other plays.
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