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 Marathon Oil Corporation (MRO)
It managed to break out of its downtrend in July this year after putting in a double bottom formation and has been putting in a series of higher lows since the 22nd June. When a stock puts in a series of higher lows it is usually a bullish development. The stock also broke past a zone of former resistance turned into support, and it has managed to stay above this level. As this zone has now turned from resistance into support, there is a pretty good chance that it will test this level again before trending higher. A weekly close above 28.90 would be a bullish development and signal that the stock is ready to test the 32-34 ranges.
The Jan 2013 26 puts are currently trading in the 1.68-1.72 ranges. If the stock pulls back to the stated ranges, these puts should trade in the 2.10-2.25 ranges. For this example we will assume that the puts can be sold at 2.10 or better. For each contract sold, $210 will be deposited into your account.
Benefits of this strategy
If the stock trades below the strike price, the shares could be put to your account. If this comes to pass, you will have the chance 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 $23.90. If the shares are not assigned to your account, you will walk away with a very decent gain of 8.8 in roughly six months.
Your Potential Risk
The risk is limited if you are bullish on the stock. 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). On the other hand, if the shares are not assigned to your account, you at least getting paid for trying to. When you put in a limit order, it is either filled or not. If it's not filled you are not paid for your efforts.
If for some reasons you have a change of heart after selling the puts, because maybe 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 $23.90.
For those looking to boost their gains the following strategy could be employed:
You could take some of the premium you received from the puts you sold to purchase some out of the money calls. For example, you could buy the Jan 2013, 31 calls which are currently trading in the 61-65 cent ranges. If the stock pulls back to the stated ranges, these calls could trade down to the 40-50 cent ranges. This strategy allows you to leverage your position for free as the calls are purchased from the money you received for the sale of the puts. If the stock continues to trend upwards the calls could significantly rise in value.
Company: Marathon Oil Corp
- 52 week change = 8.34%
- Profit Margin = 11.8%
- Operating Margin = 30.9%
- Quarterly Revenue Growth = 1.4%
- Quarterly Earnings Growth = - 60%
- Beta = 1.4
- Percentage Held by Institutions = 1.7%
- Short Percentage of Float = 1.2%
- 5 year sales growth = -22.6%
- Gross Margins = 55
- Sales vs 1 year ago = - 79%
- Net Income ($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 = 2.5
- Dividend Yield 5 Year Average = 3.3
- 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 = 30
- Retention rate = 78%
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 - 1 Growth And 4 Dividend Plays To Consider.
Company: Cabot Oil & Gas (COG)
- 5 year sales growth rate = 5.63%
- EPS vs 1 year ago = -34%
- Sales vs 1 year ago = 16%
- Long term debt to equity = 0.46
- Gross margins = 72%
- Beta = 0.8
- Quarterly revenue growth rate = 10.4%
- Profit margins = 10.22%
- Short percentage of float = 4.3%
- 52 week change = 39%
- Levered free cash flow = - 373M
- Operating cash flow = 572M
- Net Income ($mil) 12/2011 = 122
- Net Income ($mil) 12/2010 = 103
- Net Income ($mil) 12/2009 = 148
- Net Income Reported Quarterly ($mil) = 36
- EBITDA ($mil) 12/2011 = 654
- EBITDA ($mil) 12/2010 = 597
- EBITDA ($mil) 12/2009 = 537
- Cash Flow ($/share) 12/2011 = 2.21
- Cash Flow ($/share) 12/2010 = 2.08
- Cash Flow ($/share) 12/2009 = 2.01
- Sales ($mil) 12/2011 = 980
- Sales ($mil) 12/2010 = 844
- Sales ($mil) 12/2009 = 879
- Annual EPS before NRI 12/2007 = 0.84
- Annual EPS before NRI 12/2008 = 1.05
- Annual EPS before NRI 12/2009 = 0.78
- Annual EPS before NRI 12/2010 = 0.49
- Annual EPS before NRI 12/2011 = 0.55
- Dividend Yield = 0.2
- Dividend Yield 5 Year Average = 0.4
- Dividend 5 year Growth = 3.24
- Payout Ratio = 0.12
- Payout Ratio 5 Year Average = 0.09
- 5 Year History EPS Growth = -13.73
- ROE 5 Year Average = 10.22
- Return on Investment = 3.94
- Debt/Total Cap 5 Year Average = 30.08
- Current Ratio 12/2011 = 1.05
- Current Ratio 5 Year Average = 1.02
- Quick Ratio = 0.95
- Cash Ratio = 0.61
- Interest Coverage Quarterly = 2.76
- Retention rate = 88%
Company: Linn Energy LLC (LINE)
- Levered free cash flow = $1.38B
- 52 week change = 5.65%
- Profit Margin = 65.1%
- Operating Margin = 100%
- Quarterly Revenue Growth = 18.3%
- 5 year capital spending growth rate = 9.09%
- Long term debt to equity = 1.22
- Operating Cash Flow = $92.5 million
- Beta = 0.85
- 5 year sales growth rate = 36%
- Sales vs 1 year ago = 68%
- Net Income ($mil) 12/2011 = 438
- Net Income ($mil) 12/2010 = -114
- Net Income ($mil) 12/2009 = -298
- Cash Flow ($/share) 12/2011 = 3.8
- Cash Flow ($/share) 12/2010 = 3.08
- Cash Flow ($/share) 12/2009 = 3.31
- Sales ($mil) 12/2011 = 1162
- Sales ($mil) 12/2010 = 690
- Sales ($mil) 12/2009 = 273
- Annual EPS before NRI 12/2009 = 1.73
- Annual EPS before NRI 12/2010 = 1.54
- Annual EPS before NRI 12/2011 = 1.79
- Dividend Yield = 7.4
- Dividend Yield 5 Year Average = 9.9
- Dividend 5 year Growth = 7.44
- Payout ratio = 0.56
- Next 3-5 Year Estimate EPS Growth rate = 4.9
- Current Ratio = 1.4
- Current Ratio 5 Year Average = 1.9
- Quick Ratio = 0.5
- Interest = 4.2
- Retention rate = 44%
Production rose by 30% last year and this year they intend to raise production by another 40%. The stock is overbought right now, and investors should consider waiting for a pullback before committing new money into this stock. This is a good long term play on the oil sector.
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.
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. Profit and loss chart sourced from poweropt.com. Earnings vs expectations data sourced from smartmoney.com.