Want to buy a stock at a lower price than it currently sells? Well, you can do it by selling a put.
• I like Campbell Soup (CPB). The stock price today is $31.14.
• I can sell the January 19, 2013, $30 put for $3.30.
• Your cost, should you have to buy the stock, would be $26.70.
• Currently, the shares pay $1.16 (and at least for the last 5 years, they have raised the dividend every year).
• However, let’s say the dividend stays at $1.16 AND you get put at $30. The yield you would be getting from a major worldwide soup company would be 4.34%.
• Remember that you get the premium money NOW so you need to post less money. Actually, in a cash account, you just post $26.70 for each share. You should be getting interest on the entire $30.00. (Interest rates paid by brokerage firms are totally negotiable so do threaten to move the account. There are plenty of firms wanting your business. )
January 2013 is not a long way off. As of this writing, it is less than 17 months away. You will have earned $3.30 on an investment of $26.70 so the gross percentage return is 12.36%. However, that is over 17 months. On an annual basis, the yield is 8.72%. That is better than what the stock is paying out in dividends and you have the benefit of a potential capital gains.
If the stock is above $30 on January 19, 2013, you will not get put and your obligation will end.
If you feel the stock will go down, then do NOT write a put option now. The lower t
he price of the stock, the higher amount you can get for the put and that increases your return. Remember, we are looking at a put price of $30. Personally, I do not like to go that far out in time. I try to stay in the “90-days or less” area. My costs are low so I can accept small premiums and not get chewed up by commissions. What happens if you need the money you invested sometime in the next 6 months? Well, you can always buy back the put and close out the position. If the stock remained totally unchanged at $31.14, you will make money based on the deterioration of the time factor. Six months from now, the option will only have 11 months to go. If the stock goes up, that to would help the put price to go lower. Of course, if the stock goes down from $31.14, then the put price would increase but still the time premium would be less so that stock price, in theory, can go down to $31.00 and you could still be ahead. If the dividend is increased, which I believe will happen, then the stock price should move up and the value of the put should decline. Also, should you then get put, your dividend income would be greater than what was planned.
Campbell Soup is not the only food stock available. There is Hershey, Heinz, Kraft Foods and many others that can be traded and optioned. You need to look at yields, liquidity of the option and other factors. By the way, you can buy and sell puts like stocks. The spread between the bid/asked are normally greater than in stocks but certain options are very heavily traded such as GE, another one of my favorites and in that case, the bid/ask price could be spread by 2¢.
To sell cash covered puts, you will need to be on Level 2 in the option market.
Suppose you really like Apple Inc (AAPL). Let’s see what we have here. First of all, everyone knows that Apple is very volatile. Sure things are going good by Wall Street standards but I can promise you that if Apple misses a projection made by an analyst, then the stock could drop fast and furious. In any case, I looked at the stock price today. The price is $379.50. The November 19, 2011 put at $330 (I picked that number for no reason and I have not checked a chart for support levels) will bring $9.10. So, you put up $32,100 and you earn $910 IF the stock does not fall below $330, you did not have to use any of the premium money to buy the stock. Your total cash, meanwhile, earned interest money at the brokerage account. The stock has to drop 13.04% from today until November 19, 2011. There will be one earnings report coming out by then. Your return would be 2.83% in 3 months. The annual rate would be 11.34%. Because the company does not pay a cash dividend, there will be no dividend mark down in the price of the stock. That is good for the put seller.
Is this for you? Well, it depends on you. What do you want from the market? I like option selling for making reasonable money returns with reasonable risk. If you want to be even more cautious, you can use the premium money toward the purchase of an option that protects your position. In the case of Apple, you can use part of the premium to buy the $320 put ($7.10). Hence your risk is no more than $100 for each contract and your posting requirements are only $1,000 per contract. Since you got $9.10 and paid out $7.10, your maximum profit is $200 or 20% of your risk. Do not write a put unless you really are willing to own the stock at the price you selected regardless of where the stock price goes. So, If you like Apple at $330 or $320.90 then you should be OK if it falls to $300 and you get put. If you are writing only to speculate in the stock, then do consider buying a put under the price you contracted at.
In my next article, I will write about covered calls and different ways to make use of them to enhance your return while giving you a measure of protection.
If you have any questions or comments, please contact me through the Opportunist Magazine. I am available for option consulting for a fee.
Thank you,
Warren Kaplan
Kaplan Asset Management
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