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 Akamai Technologies (AKAM):
It has tried to break out past $30 three times in the last 30 days, and so far each attempt has failed. Thus, there is a decent chance it could test the $26 ranges again before trending higher. A good tradable bottom is usually established after a stock re tests its recent lows. A weekly close above 35 will turn the trend to bullish. We would wait until it trades down to the 27.00-27.50 ranges before putting this strategy to play. It traded today as low as 28.57, so 27.50 is not that far off.
The Jan 2013 25 puts are trading in the $2.11-$218 ranges. If the stock pulls back to the stated ranges, these puts should trade in the $2.80-$3.10 ranges. For this example, we will assume we can sell the puts for $2.80. For each contract sold, $280 will be deposited into your account.
If the stock trades below 25, the shares could be assigned to your account. Your final cost per share will be $22.20 per share. If the shares do not trade below the strike price, you get to walk away with a gain of 11.2%.
As you were bullish when you put this strategy into play, you should actually be looking forward to getting into this stock at a lower price. The only risk factor is that you suddenly have change your mind. Maybe you are not as bullish as before, and, or you feel it could trade much lower than the strike price you sold the puts at. If this is the case, you can roll the put. You simply buy back the puts you sold and sell new out of the money puts. Essentially you are taking on the same risk that is associated with owning the shares. The only difference is that you have the chance to get in at a better price or at least get paid for trying. The premium from the put you sold also provides you with some downside protection. In this example, your break-even point would be $22.20.
Company: Akamai Tech
- 5 year sales growth rate 17.2%
- 5 year EPS growth rate = 17.5%
- Levered Free Cash Flow = 284.35M
- Percentage Held by Insiders = 2.96
- Number of Institutional Sellers 12 Weeks = 4
- Long term debt to equity ratio = 0.00
- Short Ratio = 1.8
- Relative Strength 52 weeks = 63
- Cash Flow 5-year Average = 1.75
- Profit Margin = 16.1%
- Operating Margin = 30.05%
- Quarterly Revenue Growth = 15.8%
- Quarterly Earnings Growth = -14.6%
- Operating Cash Flow = 456 million
- Beta = 0.77
- Percentage Held by Institutions = 82.7%
- Short Percentage of Float = 4%
- Net Income ($mil) 12/2011 = 201
- Net Income ($mil) 12/2010 = 171
- Net Income ($mil) 12/2009 = 146
- Net Income Reported Quarterly ($mil) = 43
- EBITDA ($mil) 12/2011 = 475
- EBITDA ($mil) 12/2010 = 408
- EBITDA ($mil) 12/2009 = 363
- Cash Flow ($/share) 12/2011 = 2.16
- Cash Flow ($/share) 12/2010 = 1.85
- Cash Flow ($/share) 12/2009 = 2.2
- Sales ($mil) 12/2011 = 1159
- Sales ($mil) 12/2010 = 1024
- Sales ($mil) 12/2009 = 860
- Annual EPS before NRI 12/2007 = 1.07
- Annual EPS before NRI 12/2002 = 1.34
- Annual EPS before NRI 12/2009 = 1.35
- Annual EPS before NRI 12/2010 = 1.01
- Annual EPS before NRI 12/2011 = 1.17
- Next 3-5 Year Estimate EPS Growth rate = 14.79
- ROE 5 Year Average = 13
- Current Ratio = 4.58
- Current Ratio 5 Year Average = 5.68
- Quick Ratio = 7.56
- Cash Ratio = 6.14
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.
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.
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 yahoofinance.com If the stock trades down to the stated ranges we could put this strategy into play.