Summary: On Tuesday, I sold 10 March 2010 $10 puts on A-Power Energy Generations Systems, Ltd. (OTC:APWR), for a net credit of $1,700 less commissions. A-Power closed Tuesday afternoon at $11.39 per share. Because I have sold the puts "naked," cash collateral of $2,700 as of Tuesday's close was required (this collateral will increase or decrease depending on the underlying stock's price movement).
Rationale: A-Power's core business is building onsite power generations systems in China, but it also has a rapidly growing wind turbine design and manufacturing business. This year it has won several contracts to build turbines for various partners in China, entered into a joint venture to build turbines with General Electric, and this week announced its participation in a $1.5 billion wind farm project in west Texas. The stock is a true growth story - revenue was $152M in FY 2007, $264M in FY 2008, and analysts estimate revenue to be $324M in FY 2009 and $574M in FY 2010. Earnings have followed a similar upward path. Nevertheless, the stock trades at less than 9x projected forward earnings and less than 15x trailing earnings. The company's balance sheet is pristine with roughly $40M cash and no debt.
That being said, the stock is tremendously volatile and its future is tied to the continued demand for a rather speculative product in a developing market. By selling out of the money puts, I can target a much more conservative purchase price, in this case effectively $8.3 ($10 strike price less $1.70 in premiums), which is around 26.5% below its current price, and would be less than 10x trailing and 7x forward earnings. In the event the puts are not exercised and the puts expire worthless, I will have generated a real return of 20.4% on my reserved cash (less the option premium) over a five month period (IRR of roughly 65%). Note that because this stock is very volatile, the options hold the level of premium necessary to generate this sort of return. Because I'd be glad to purchase the stock at $8.3 per share and go long, I can use high volatility to my advantage as a value-driven investor. Note the difference between this approach and merely selling high vega to generate higher returns.
Disclosure: Long APWR