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Richard Berger
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Mr. Berger is the creator and developer of the YDP screening tool. A chart system and its analysis for screening and monitoring dividend income equity investments. Seeking Alpha's #3 ranked Author for Income Investing Strategy & #4 for Utilities. A former Chief Operating Officer, Director,... More
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  • How To Buy Stocks Wholesale (SSW On Sale At 9.4% Discount) 5 comments
    Jan 29, 2013 6:56 AM | about stocks: SSW

    When was the last time you had the opportunity to buy a television, a room full of new furniture, a computer, home appliances, a car, or even your favorite Starbucks triple grande sugar free vanilla soy latte frappuccino and chose to pay full retail price for it even when given the option to buy at a wholesale discount price?

    If you answered "all the time" then you probably buy stocks the same way. If you answered almost never, then its time you started to buy stocks at a discount from retail also. I'm not talking about discount brokers, although they too should be your preferred "outlet mall".

    What I am edging you slowly towards is the idea of using cash covered puts to pay a discounted price for stocks you want to buy anyway. You are not using the options to speculate, to hedge, or anything but cut your entry price (and maybe also generate some direct cash rebates to you along the way).

    Selling a cash covered put to open a contract may sound very technical to a first time option user. Perhaps you have heard that puts are used to hedge against the price of a stock going DOWN so wonder why I want you to consider them for a stock you want to hold long because you expect it to go UP. Ok, ok, I'm not crazy, give me a minute and it will all become clear (or at least clearer).

    First do your research to find a company that meets your buy criteria. It is in a Country that gives you geographic exposure where you want to be, trades in a currency that provides diversity and stability to your portfolio, has appropriate legal and political risk, meets fundamental criteria of cash flow, debt ratios, PEG, etc, has the growth and dividend yield you seek, a beta in the volatility range you are comfortable with, a technical chart that shows it now trading at or very near a good entry price point. Given all that, its time to buy. Hold on! Don't place that buy order. We're going to the discount window to make our purchase.

    Lets use a real world example from a stock that caught my eye after my screener scooped it up and it survived my screening for all the above criteria. We'll examine SeaSpan Corporation (NYSE:SSW).

    SSW is a container ship owner and operator that charters its vessels under long term fixed price contracts. This business is cyclical and like the rest of the shipping industry will benefit from an improving economy and growing world trade. As of close on 28 January 2013, the stock is at $18.81 with a dividend yield of 5.4% and is in an accelerating uptrend since 15 November 2012. For all the various fundamental, technical, and personal portfolio management reasons relevant to me personally, I find the stock ready for a breakout to the upside at around $18.50 and set this as the entry point I like. Indeed, 28 January may have been the breakout with the stock surging at the open from $18.40 to $18.74 and closing at its high for the day at $18.81.

    Am I too late to catch the bus? Should I make the leap at $18.81 retail and not miss this shipper as it surges out of the harbor? No to all the above. I'm going to buy it for $17.50 per share on 29 January or get someone to PAY ME $0.40 per share not to buy it. Forty cents per share is 2.3% of my $17.50 wholesale entry point price. I will agree to be patient and wait until as late as March 16th to buy the stock from the owner of the March $17.50 strike price puts that I sell to them. If they have not sold me their stock by March 16th then I will simply keep the $0.40 per share they paid me on 29 January and we'll forget the whole deal (the put contract will have expired).

    What will happen between 29 January and 16 March to the stock price? Nobody can say for sure, but lets look at the key possibilities and how they effect me as the seller of the cash covered puts.

    1. The stock stays within its trend lines and meets resistance around $19/share where it then settles into a consolidation pattern or continues higher. The short summary is it closes above $17.50 on March 16th. In this case I pocket the $0.40 per share that I was paid as a premium for selling the put option. I am ahead .40/17.50 = 2.3% on the money I tied up for 47 days covering the put in case I needed to use that cash to buy the stock if it was presented to me. 2.3% for 47 days calculates to a 17.6% annualized yield non-compounded. This is 3 times greater than the dividend yield on the stock which is one of the screening criteria I used to select it in the first place. I will never be unhappy with a 17.6% annual yield on any of my investments so long as annual inflation rates are below 12%. I have no regrets at all if I "missed out" on even greater profits from the stock's upsurge in price. I would be speculative at best and overly optimistic to believe I would exit the stock at some ideal high point in its price oscillations anyway.

    2. What if the stock takes a hard drop? This is the downside of holding the stock or holding the obligation to buy the stock by having sold the put options. You will note that the downside risk is actually LESS for holding the put obligation since I was paid $0.40 cents per share premium and thus the stock would have to fall all the way back down below $17.10 before I am in the loss column as opposed to just falling below $18.81 if I had simply bought the stock at retail on the morning of 29 January. I have in this situation bought the stock at a discount of $1.71 from the 29 January retail price. A discount of 9.4% from that retail price and I did so without adding any risk to the trade since by definition I was willing and interested in entry to the stock at the $18.81 price for dividend yield and possible price appreciation. In summary, this "worst case" scenario has left me with LESS risk, smaller or no loss than the "retail" buy would have, and given me a 9.4% pricing advantage over all the buyers who entered the same day I made my cash covered put trade.

    3. A further choice available to me if the stock is presented to me under the put contract at $17.50 is to hold it for dividend yield and possible price appreciation since this was my original attraction to the stock anyway. If my fundamental analysis has not changed then this becomes a very real possibility. The difference being that my dividend yield is not the 5.4% based on the $18.81 basis price but instead is based on my $17.10 basis cost (17.50 minus the 40 cent option premium I was paid). This increases my effective dividend yield to 5.8% instead of the 5.4% that retail buyers settled for. A 9.4% discount from retail AND a 7.5% increase in dividend rate. Will you ever pay retail again?

    I hope this example has shown you how to buy stocks at a discount. I generally will demand at least a 1.5% per month option premium for a put priced at least 5% out of the money (below the current trading price of the stock). Technical chart criteria may modify this somewhat on case by case basis.

    One last note: The example used here is a real trade opportunity and may make sense to some investors. I personally am adverse to the extremely high volatility of shipping stocks in general and do not invest in that particular industry. Your criteria may very.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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Comments (5)
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  • HiloBeMagical
    , contributor
    Comments (357) | Send Message
     
    "3. A further choice available to me if the stock is presented to me under the put contract at $17.50 is to hold it for dividend yield and possible price appreciation since this was my original attraction to the stock anyway. If my fundamental analysis has not changed then this becomes a very real possibility. The difference being that my dividend yield is not the 5.4% based on the $18.81 basis price but instead is based on my $17.10 basis cost (17.50 minus the 40 cent option premium I was paid). This increases my effective dividend yield to 5.8% instead of the 5.4% that retail buyers settled for."

     

    Greetings, and thanks for the blog post. With me, you're preaching to the choir as I never enter a position without a sold put.

     

    I'm writing to address what I perceive as an error in your section 3.

     

    We put sellers don't get to "have it both ways". If you are calling your put premiums a 'return' on your secured cash, they can't be used to lower your cost basis _for the purpose of juicing your dividend yield_.

     

    We know the tax guys use the lowered cost basis, but for purposes of determining yields we can't. The put premium is yield on secured cash. Once the stocks are assigned the dividends paid are figured as yield on _assigned_ price. If not, you're crediting cash dollars from the puts with the power to affect two different "yields". It's one or the other, not both.

     

    I know it's kind of nit picking, and I used to figure as you did, but if you think about it, I think you'll see the point.

     

    All the best and thanks for the blog,
    Hilo
    30 Jan 2013, 07:00 PM Reply Like
  • Richard Berger
    , contributor
    Comments (956) | Send Message
     
    Author’s reply » Your observations are correct. I have not tried to double dip in my accounting, but rather just to highlight the way to analyze what's going on. For investment *analysis* adjusting the cost basis and computing annualized rate of return makes sense even if its not a tax treatment. Likewise the premium and dividends are obviously income, not cost basis adjustment and certainly not BOTH when it comes to the actual investment returns.

     

    Thanks for your comments. You may find my latest blog on Chile's PVD of interest.
    30 Jan 2013, 07:11 PM Reply Like
  • Yield Hunter
    , contributor
    Comments (294) | Send Message
     
    Do you sell covered calls to juice premiums of holdings also? Why or why not?
    4 Feb 2013, 01:51 PM Reply Like
  • Richard Berger
    , contributor
    Comments (956) | Send Message
     
    Author’s reply » Yes, I selectively use covered calls to add yield on my holdings when I believe the strike price will lay outside the trading range channel and is not likely to be hit and/or the premium is so good that even if my stock is called away I will be happy to repurchase more of it or take my profit and find a new home in a better valued stock if my covered calls have moved beyond reasonable value at the strike price I write.
    My one caveat is on taxes. If you have large taxable gains in a taxable account then the call premiums need to not only justify the compensation to you for calling it away but need to do so on an AFTER TAX basis. I have a very large holding of STWD with about a 30% unrealized capital gain. I have been wishing for over a year I could write some covered calls on this holding but the strike price/premiums have not come anywhere close to being of interest to me after netting out the tax consequences if it did get called away from me. At least meantime it does yield 6.8% and keeps going up up and up beyond all reasonable expectations.
    I will probably do a value analysis of STWD soon to see where my stop loss should be on it and if it remains a good hold or time to exist and pay the tax man.
    4 Feb 2013, 02:08 PM Reply Like
  • jmgleit
    , contributor
    Comment (1) | Send Message
     
    If the strike price is reached and you expect the stock to continue up you can close out the option and sell another at a higher strike further out (hopefully for a higher premium than the one that was bought) in order to cover the cost of closing out the original option.
    28 Feb 2013, 05:05 AM Reply Like
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