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.
Suggested Put Strategy for Marathon Oil:
The stock is attempting to put in a bottom as the 23.00 ranges have been tested twice over the past two months, and they have held. However, the stock will remain in a downtrend till it closes above 27.00 on a weekly basis. Until then, it has a decent chance of testing its lows (23 ranges) again and possibly spiking a low as 21 on an intra day basis.
The Jan 2013, 22 puts are trading in the 1.49-1.52 ranges. If the stock pulls back to the 22.50-23.50 ranges, these options should roughly trade in the 1.90-2.25 ranges. For this example, we will assume that the puts can be sold for $1.90. For each contract sold, $190 will be deposited into your account.
If the stock trades below the strike price, the shares could be assigned to your account. You have the opportunity of getting into this stock at a much lower price. Your final price in this case will be 20.10 (22.00 minus 1.90). If the stock is not assigned to your account, you get to walk away with a gain of 8.36% in seven months.
You were prepared for the possibility that the shares could be assigned to your account in the event they traded below the strike price. The only risk factor is that you have a change of heart along the way, and you feel that the stock might trade significantly below the strike price. In this case, you can roll the puts. Buy the puts you sold back and sell new slightly out of the money puts.
Company: Marathon Oil Corp (MRO)
- Percentage Held by Insiders = 0.87
- Levered Free Cash Flow = 2.01B
- Relative Strength 52 weeks = 17
- Cash Flow 5-year Average = 7.67
- Profit Margin = 15.97%
- Operating Margin = 28.54%
- Quarterly Revenue Growth = 3%
- Quarterly Earnings Growth = -58.1%
- Beta = 1.27
- Percentage Held by Institutions = 1.7%
- Short Percentage of Float = 1.2%
- Net Income ($mil) 12/2011 = 2946
- Net Income ($mil) 12/2010 = 2568
- Net Income ($mil) 12/2009 = 1463
- Net Income Reported Quarterly ($mil) = 417
- EBITDA ($mil) 12/2011 = 6800
- EBITDA ($mil) 12/2010 = 6188
- EBITDA ($mil) 12/2009 = 4819
- Cash Flow ($/share) 12/2011 = 6.48
- Cash Flow ($/share) 12/2010 = 6.56
- Cash Flow ($/share) 12/2009 = 4.37
- Sales ($mil) 12/2011 = 15282
- Sales ($mil) 12/2010 = 73621
- Sales ($mil) 12/2009 = 54139
- Annual EPS before NRI 12/2007 = 5.43
- Annual EPS before NRI 12/2008 = 6.47
- Annual EPS before NRI 12/2009 = 1.63
- Annual EPS before NRI 12/2010 = 3.65
- Annual EPS before NRI 12/2011 = 3.21
- Dividend Yield = 2.7
- Dividend Yield 5 Year Average = 2.53
- Dividend 5 year Growth = -0.83
- Payout Ratio 03/2012 = 0.22
- Payout Ratio 5 Year Average = 0.26
- Next 3-5 Year Estimate EPS Growth rate = 2.06
- ROE 5 Year Average = 15.63
- Current Ratio = 0.70
- Current Ratio 5 Year Average = 1.19
- Quick Ratio = 0.65
- Cash Ratio = 0.21
- Interest Coverage Quarterly = 27.88
- Retention rate = 78%
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.
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.
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.