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 CSX Corp. (CSX)
The stock is still trading well off its 2 year high set on July 2011 and has been putting in a bullish series of higher lows since September 2011 as indicated by the chart below.
As there is the 23.50-23.75 ranges offer a pretty strong zone of resistance, there is a good chance that it could test the 22 ranges again before breaking out. As long as it does not close below 19.88 the short term to midterm outlook will remain neutral to bullish. A weekly close above 23.75 will turn the short- term outlook to bullish and indicate that is a pretty decent chance it could trade to the 26-27 ranges with the possibility of spiking past 28 on an intraday basis.
The Jan 2013, 21.67 puts are trading in the $1.21-$1.24 ranges. Sell these puts at $1.22 or higher. For this example, we will assume that the puts can be sold at $1.22. For each contract sold $122 will be deposited into your account.
Benefits of this strategy
If the stock trades below the strike price, the shares could be assigned to your account. If this occurs, you have the opportunity of getting into a stock you like at a much lower price. Your final price when the premium is factored in will work out to $20.45. If the shares are not assigned to your account, you will walk away with a gain of 6% in six months, which works out to a healthy yearly yield of 12%.
Your potential Risk
As long as you are bullish the risk is limited. Essentially you are taking on the same level of risk as you would if you bought the shares outright, but with the added benefit of getting in at a lower price (via the premium you received). 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.
As a reminder only put this strategy into play if you are bullish on the stock and prepared for the shares to be put to your account. 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. Your breakeven point in this trade is $20.45.
A suggestion to boost your potential gains
If you are looking for a way to leverage your position, then this strategy could prove to be useful.
Take some of the premium you received from the puts you sold to purchase some out of the money calls. For example, you could purchase the Nov 2012, 25 calls. The last trade was at 34 cents. At that price, you could purchase several calls with the proceeds you received from the sale of the puts.
If the stock trades to the suggested ranges, these options could significantly rise in value. More importantly, the calls are free as you are using the money obtained from selling the puts to leverage your position.
For investors looking for other ideas detailed data has been provided on two additional companies. Our latest article could also provide some food for thought A Broad Range Of Dividend And Growth Plays To reflect on.
Company: QR Energy LP (QRE)
- Short Ratio = 0.4
- Levered Free Cash Flow = 116.07M
- Relative Strength 52 weeks = 47
- Profit Margin = 38.22%
- Operating Margin = 57.49%
- Quarterly Revenue Growth = 4.7%
- Operating Cash Flow = 93.18M
- 13. Percentage Held by Institutions = 7.3%
- Short Percentage of Float = 0.9%
- Net Income ($mil) 12/2011 = 61
- Net Income ($mil) 12/2010 = 2
- Net Income ($mil) 12/2009 = -8
- Net Income Reported Quarterly ($mil) = -7
- EBITDA ($mil) 12/2011 = 187
- EBITDA ($mil) 12/2010 = 123
- EBITDA ($mil) 12/2009 = -93
- Cash Flow ($/share) 12/2011 = 6.05
- Cash Flow ($/share) 12/2010 = 3.54
- Sales ($mil) 12/2011 = 260
- Sales ($mil) 12/2010 = 253
- Sales ($mil) 12/2009 = 73
- Dividend Yield = 11.4
- Annual Dividend 12/2011 = 1.65
- Payout Ratio = 3.98
- Debt/Total Cap 5 Year Average 03/2012 = 65.28
- Current Ratio = 0.82
- Current Ratio 5 Year Average = 1.06
- Quick Ratio = 1.44
- Cash Ratio = 0.84
- Interest Coverage = 1.50
Company: Atlas Pipeline Partners (APL)
Levered Free Cash Flow = -173.59M
- Short Ratio = 2.3
- Relative Strength 52 weeks = 59
- Cash Flow 5-year Average = 5.3
- Profit Margin = 9.10%
- Operating Margin = 10.5%
- Quarterly Revenue Growth = -4.8%
- Quarterly Earnings Growth = 914
- Beta = 1.72
- Percentage Held by Institutions = 37.5%
- Short Percentage of Float = 3.3%
- Net Income ($mil) 12/2011 = 289
- Net Income ($mil) 12/2010 = 276
- Net Income ($mil) 12/2009 = 60
- Net Income Reported Quarterly ($mil) = 5
- EBITDA ($mil) 12/2011 = 409
- EBITDA ($mil) 12/2010 = 128
- EBITDA ($mil) 12/2009 = 171
- Cash Flow ($/share) 12/2011 = 3.01
- Cash Flow ($/share) 12/2010 = 0.87
- Cash Flow ($/share) 12/2009 = 1.79
- Sales ($mil) 12/2011 = 1303
- Sales ($mil) 12/2010 = 936
- Sales ($mil) 12/2009 = 904
- Annual EPS before NRI 12/2007 = 1.76
- Annual EPS before NRI 12/2008 = 2.41
- Annual EPS before NRI 12/2009 = -0.13
- Annual EPS before NRI 12/2010 = -0.65
- Annual EPS before NRI 12/2011 = 1.3
- Dividend Yield = 6.8
- Dividend Yield 5 Year Average 03/2012 = 9.45
- Annual Dividend 12/2011 = 1.78
- Dividend 5 year Growth 03/2012 = -13.18
- Payout Ratio = 2.15
- Payout Ratio 5 Year Average 03/2012 = 1.46
- ROE 5 Year Average 03/2012 = 6.91
- Debt/Total Cap 5 Year Average 03/2012 = 48.1
- Current Ratio = 0.77
- Current Ratio 5 Year Average = 0.74
- Quick Ratio = 0.77
- Cash Ratio = 0.1
- Interest Coverage Quarterly = 1.74
Quarterly earnings growth increased from - 97.9% in the 1st quarter to 914% in the second quarter.
This strategy should only be implemented if you are bullish on the stock as there is a chance that the shares could be assigned to your account. The benefit of this strategy is that it provides you with the opportunity of getting into a stock you like at a price of your choosing or getting paid for your efforts.
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. Earnings and growth rates obtained from dailyfinance.com. Option profit and loss graph sourced from poweropt.com