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Selling naked 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

  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. 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 Southern Copper (NYSE:SCCO)

It has tested the $32 ranges several times since March of this year, and each time it could not hold onto its gains. The latest attempt to break out occurred on the 3rd and 4th of this month, and once again, it failed. Thus, there is a good chance that it could test its lows in the $28 ranges again. If you have no position and are bullish on this stock, then divide your money into several lots and put in a limit order at price you would not mind owning the stock. While selling puts is a good way to get into a stock you like at a price of your choosing, there is always the chance that the shares might not be put to your account.

In terms of this strategy consider dividing your money into two lots and deploy one lot if and when the stock trades down to the $28.00-$28.50 ranges. You can deploy the second lot if and when the stock trades below $28.00. If this comes to pass consider selling puts with strikes in the 23-25 ranges with the remaining money.

The Jan 2013 29 puts are trading in the $2.35-$2.65 ranges. If the stock pulls back to the suggested ranges these puts will be in the money and should be trading roughly in the $3.20-$3.50 ranges. We will assume that the puts can be sold for $3.20 if the stock trades down to the suggested ranges. For each contract sold $320 will be deposited into your account. Note if you are bullish on the stock right now you can sell the puts at the current going rate. Your entry price if the shares are assigned to your account will be higher, and if they are not, the gains you stand to make from the premium will be lower.

Benefits of this strategy

If the stock trades below the $29.00, the shares could be put to your account. This usually occurs on the expiration day, so if on the expiration day the stock is trading at or above $29.00, you will most likely walk away with the premium. If the stock is trading well below $29.00 and the shares are assigned to your account, you will get in at a much lower price. In this case, your final price will work to $25.80 per share ($29.00 minus $3.20). If the shares are not assigned to your account, you walk away with a gain of 11% in seven months.

Your potential Risk

The only risk factor is that you have a change of heart after selling the puts, and you now feel that the stock could trade well below the strike price. If this is the case, you can roll the put. Purchase the put you sold back and sell new slightly out of the money puts. Your break-even point for this trade is 25.80.

Company: Southern Copper

Basic overview

  1. Levered free cash flow = 1.57 billion
  2. Quarterly revenue growth = 12.7%
  3. Quarterly earnings growth = 30%
  4. Profit margins = 35%
  5. Beta = 1.93
  6. Short ratio = 5.7%
  7. Percentage held by insiders= 80.9%
  8. Operating cash flow = $2.28B
  9. Cash Flow 5 -year Average = 2.22
  10. Long term debt to equity= 0.61
  11. 5 year capital spending growth rate = 7.26%

Growth

  1. Net Income ($mil) 12/2011 = 2336
  2. Net Income ($mil) 12/2010 = 1554
  3. Net Income ($mil) 12/2009 = 929
  4. EBITDA ($mil) 12/2011 = 3923
  5. EBITDA ($mil) 12/2010 = 2873
  6. EBITDA ($mil) 12/2009 = 1776
  7. Net Income Reported Quarterly ($mil) = 621
  8. Cash Flow ($/share) 12/2011 = 3.09
  9. Cash Flow ($/share) 12/2010 = 2.14
  10. Cash Flow ($/share) 12/2009 = 1.4
  11. Sales ($mil) 12/2011 = 3193
  12. Sales ($mil) 12/2010 = 5150
  13. Sales ($mil) 12/2009 = 3734
  14. Annual EPS before NRI 12/2007 = 2.48
  15. Annual EPS before NRI 12/2008 = 1.58
  16. Annual EPS before NRI 12/2009 = 1.08
  17. Annual EPS before NRI 12/2010 = 1.81
  18. Annual EPS before NRI 12/2011 = 2.76

Dividend history

  1. Dividend Yield = 6.80
  2. Dividend Yield 5 Year Average = 6.20
  3. Dividend 5 year Growth = - 0.53

Dividend sustainability

  1. Payout Ratio = 0.70
  2. Payout Ratio 5 Year Average = 0.87

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 17.58
  2. ROE 5 Year Average = 42.76
  3. Return on Investment = 34.47
  4. Debt/Total Cap 5 Year Average = 31.24
  5. Current Ratio = 3.60
  6. Current Ratio 5 Year Average = 3.5
  7. Quick Ratio = 2.70
  8. Cash Ratio = 1.58
  9. Interest Coverage = 20.40

Conclusion

The key ingredient before putting this strategy to use is that you are bullish on the long-term prospects of this stock. Do not put this strategy into play if you are not bullish on the stock.

If you have no position in this stock and want to establish a position, then consider dividing your money into 2-3 lots. Use one lot to put in a limit order at price you would not mind owning the stock at, as there is always chance that the shares might not be assigned to your account. You can then use the remaining money to put this strategy to use. Selling puts provides one with the chance to get into a stock at price of one's choosing or to get paid for trying to. If you are looking for other investment ideas, you might find this article to be of interest Silver Wheaton: Get In At $20 Or Grab An Extra 13%.

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. Earning estimates and growth rates sourced from dailyfinance.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

Source: Southern Copper Bulls: In At $25.80 Or Earn An Extra 11%