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.
- 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.
- 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 EMC Corporation (EMC):
- One of the major drivers of future growth will come from Cloud computing and big data initiatives. Forrester predicts the global market for cloud computing will grow from $40 billion to $241 billion by 2020. Large corporations are projected to increase their IT spending on cloud computers. EMC stands to benefit from this as it already has some influence with large enterprises given its leadership role in the storage market; it will be able to cross market its infrastructure solutions to these enterprises going forward.
- EMC's strategic and aggressive acquisition policy has been mainly responsible for the company's strong position in the data-storage market. Acquisitions have helped it enhance and expand its information storage, content management and archiving segments. Management is now focusing on increasing the company's footprint in the very rapidly growing big data-management market.
- It benefits from the strategic technology alliances it has with a large number of companies such as Cisco systems, Brocade, Citrix, Microsoft, Oracle, and VMware.
- The introduction of new product lines such as VNX unified storage, Symmetrix VMAX families and products from Isilon helped drive market share growth.
- Gartner predicts that IT spending over 2010-2015 periods will be mainly focused on computing hardware of which data storage is a major component. This will help drive future growth and should help it gain significant market share from its peers. Worldwide data center hardware spending is projected to reach $106.4 billion by the end of 2012, and the projections that it will surpass the $127 billion mark by 2015. EMC is well positioned to reap the benefits from this increase in spending going forward.
- EMC repurchased 81.8 million shares in 2011 at a cost of roughly $2 billion and deploy another $700 million to repurchase shares in 2011; this should provide an additional boast to earnings going forward.
- It is the top provider of storage software and systems. Market research firm IDC indicates that EMC maintained its supremacy in the external storage system, disk storage system and storage software with 28.5%, 28.5% and 41.6% of the market share respectively. It edged out rivals NetApp and IBM.
- A 5 year sales growth of 10.16%
- A 5 year EPS growth rate of 10.49
- A long term debt to equity ratio of 0.01
- Year over year projected growth rate of 15.5 and 16.8% in 2012 and 2013 respectively.
- Net income surged from $1.08 billion in 2009 to $2.4 billion in 2011
- Cash flow per share increased from $1.15 in 2009 to $2.07 in 2011
- Sales jumped from $14 billion in 2009 to $17 billion in 2011
- Annual EPS before NRI increased from $0.72 in 2007 to $1.25 in 2011
- It has projected EPS growth rate for the next 3-5 years of 16%
- It sports a superb interest coverage ratio of 23.8
Suggested Put Strategy for EMC
EMC appears to be putting in a bottom after dropping all the way to 22.77 from 30.00. During the early stages of a bottoming process the lows are usually tested several times. If the pattern is bullish the stock usually puts in higher lows. Thus it is reasonable to expect that it could test the 23.00-23.50 ranges again before trending upwards.
The Jan 2013, 23 puts are trading in the 1.15-1.20 ranges. If the stock pulls back to the stated ranges these options should roughly trade around the same levels as the Jan 2013, 25 puts are trading at presently. For this example, we will assume that these puts can be sold at $1.80. For each contract sold, $180 will be deposited into your account.
Benefits and Risks associated with this strategy
If the stock trades below the strike price, the shares could be assigned to your account. If the shares are assigned to your account, your final cost will be 21.20 per share. If the stock does not trade below the strike price, you get to walk away with a gain of 7.8%
Risks
As you were bullish on this stock when you put this strategy into play, there is no risk as you were prepared for the possibility of having the shares assigned to your account. The only risk factor is that you have a change of heart along the way. Maybe you feel the stock is going to trade a lot lower. In this case, you can roll the puts. Buy the puts you sold back and sell new slightly out of the money puts.
Related companies
For investors looking for other ideas some data has been provided on two additional companies to get you started.
Seagate Technology PLC (STX)
Basic overview
- Levered Free Cash Flow = $761 million
- Beta= 2.64
- Short ratio = 1.3%
- Operating margins= 17%
- Operating cash flow = 2.13 billion
Net income for the past three years
- Net Income 2009 = $-31. Billion
- Net Income 2010 = $1.6 billion
- Net Income 2011 = $511 million
Total cash flow from operating activities
- 2009 = $ 823 million
- 2010 = $ 1.9 billion
- 2011 = $ 1.26 billion
Gross Profit
- 2009 = $ 1.4 billion
- 2010 = $ 3.2 billion
- 2011 = $ 2.1 billion
Performance
- Dividend yield 5 year average = 4.00
- Dividend growth rate 5 year average = 1.7%
- 5 year sales growth= 0.98
- Quarterly revenue growth= 65%
- Profit margins = 14.7%
- Quick Ratio = 1.4
- Current Ratio = 2.00
- Long term debt to equity= 0.78
- Interest Coverage = 9.00
- Payout Ratio = 18%
Western Digital Corp. (WDC)
Basic overview
- Levered Free Cash Flow= $821 million
- Beta= 1.48
- Short ratio = 1.9%
- Operating margins= 13.8
Net income for the past three years
- Net Income 2009 = $470 million
- Net Income 2010 = $ 1.3billion
- Net Income 2011 = $726 million
Total cash flow from operating activities
- 2009 = $ 1.3 billion
- 2010 = $ 1.9 billion
- 2011 = $ 1.6 billion
Gross Profit
- 2009 = $1.3 billion
- 2010 = $2.4 billion
- 2011 = $ 1.79billion
Performance
- 5 year sales growth= 12.31%
- Quarterly revenue growth= 34%
- Quarterly earnings growth= 230%
- Profit margins = 10.12%
- Quick Ratio = 1.3
- Current Ratio = 1.6
- Long term debt to equity= 0.27
- Interest Coverage = 57
Conclusion
Only implement this strategy if you are bullish on the stock, and you are ready for the possibility that the shares could be assigned to your account. In general, selling puts is one of the best ways to get into a stock you are bullish on. You either get in at a lower price, or you get paid for trying to.
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
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/research data used in this article was obtained from zacks.com. Options tables sourced from money.msn.com.
