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
- 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 Goldman Sachs (GS):
It has rather strong support in the 90 ranges. It has tested this zone twice and held and is now attempting to break out. There is a fairly decent chance it will pull back to the 93-95 ranges before trending higher. It also has a stiff amount of resistance at $100. A weekly close above this level on good volume should take the stock well above 110. If you are patient consider waiting for a test of the $95 ranges before putting this play into action.
The Jan 2013, 95 puts are trading in the $6.95-$7.15 ranges. If the stock pulls back to the stated ranges these options should trade roughly in the $8.70-$9.00 ranges. We will assume that we can sell the put for $8.75 if the stock pulls back to the stated ranges.
Benefits of this strategy
If the stock trades below the strike price, the shares could be put to your account. In this case, you will have the chance of getting into the stock a stock you like at a much lower price. Your final price when the premium is factored in will work out to $86.25 per share. If the stock is not assigned to your account, you walk away with a gain of 9.2% in roughly seven months. If you are bullish on the stock at current levels, you can sell the Jan 2013, 95 puts at $7.00 or better. If the shares are not assigned to your account, you will walk away with a gain of 7.3%
Your potential Risk
The risk is limited if you are bullish on the stock and would not mind owning shares at a lower price. As you were willing to buy the shares in the first place, you should be even happier if they are assigned to you at a lower price. Essentially the risk is the same as buying the shares outright but with the added benefit of getting in at a lower price (via the premium you received) or getting paid for your efforts. When you put in a limit order, it is either filled or not. If it's not filled you do not get paid for trying.
If on the other hand, you are just putting this strategy to use because you are tempted by the short-term gains you are taking on more risk because the shares could be assigned to your account, and the stock could trade well below the strike price.
Thus only put this strategy to use if you would not mind owning these shares at a lower price. Now if you have a change of heart after selling the puts because you now feel that the stock could trade significantly below the strike price, then you can roll the puts. Buy back the old puts and sell new slightly out of the money puts with more time on them. This procedure usually allows you to walk away with a net credit. Your breakeven point in this trade is $86.25.
Company: The Goldman Sachs Group
- Percentage Held by Insiders = 6.75%
- Profit Margin = 14.2%
- Operating Margin = 20.85%
- Quarterly Revenue Growth = - 16 %
- Quarterly Earnings Growth= - 22%
- Operating Cash Flow = 23.28B
- Beta = 1.63
- Percentage Held by Institutions = 20%
- Short Percentage of Float = 1.2%
- Sales vs 1 year ago = -20%
- Long term debt to equity ratio = 2.50
- Net Income ($mil) 12/2011 = 4442
- Net Income ($mil) 12/2010 = 8354
- Net Income ($mil) 12/2009 = 13385
- EBITDA ($mil) 12/2011 = 16020
- EBITDA ($mil) 12/2010 = 21602
- EBITDA ($mil) 12/2009 = 28272
- Cash Flow ($/share) 12/2011 = 12.82
- Cash Flow ($/share) 12/2010 = 22.23
- Cash Flow ($/share) 12/2009 = 29.82
- Sales ($mil) 12/2011 = 28811
- Sales ($mil) 12/2010 = 39161
- Sales ($mil) 12/2009 = 51673
- Annual EPS before NRI 12/2007 = 24.73
- Annual EPS before NRI 12/2008 = 4.47
- Annual EPS before NRI 12/2009 = 22.13
- Annual EPS before NRI 12/2010 = 15.22
- Annual EPS before NRI 12/2011 = 4.51
- Dividend Yield = 1.90
- Dividend Yield 5 Year Average = 1.01
- Dividend 5 year Growth = 0.11
- Payout Ratio = 0.20
- Payout Ratio 5 Year Average = 0.14
- Next 3-5 Year Estimate EPS Growth rate = 21.33
- E5 Year History EPS Growth = -17.92
- ROE 5 Year Average = 17.22
- Return on Investment = 1.55
- Debt/Total Cap 5 Year Average = 76.46
- Current Ratio = 0.79
- Current Ratio 5 Year Average = 0.99
- Quick Ratio = 0.79
- Interest Coverage = 1.70
- Retention rate = 80%
Only implement this strategy if you are bullish on the stock, and you are ready for the possibility that the shares could be put to you. Selling puts is one of the better methods of getting into a stock you are bullish on. You either get in at a lower price, or you get paid for trying to. Investors looking for other ideas might find this article to be of interest Southern Company: Get In At $38.30 Or Earn An Extra 8.8%.
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 yahoofinance.com