Selling Cash-Secured Put Options

[This article is also posted on Seeking Alpha HERE.]
Selling puts on stocks can be a good way to either gain some yield and/or try and buy a stock you'd like to own at a lower price. I prefer cash-secured puts so that if the stock gets put to you, there is cash available to buy the stock. So when looking at the attractiveness of selling cash-secured puts, I view my outcome as either: 1) the yield I gain on the cash I'm reserving in case the stock gets put to me; or 2) buying the stock at the net price (exercise price per share minus premium received per share). Below are a few examples of stocks that value managers own today where it may be worthwhile to sell the puts for those interested in establishing positions (a mid-range between the bid/ask on the puts at the time of this post was used in the calculations).

Sears Holdings (SHLD) - January 2013, $30.00 strike puts: Sell for $11.00 per share.

Scenarios:

1. About a 58% total return ($11 received per share in premium / $19 per share reserved in case the stock gets put to you) if the stock expires without getting put to you over about a 13 month holding period.
2. You buy the stock (if it gets put to you) for a net $19 per share.

The price below which you'd start to lose money on this trade would be $19 per share. At this point, the stock could get put to you and you'd have to buy it at a net price above where the stock would be trading.

Bank of America (BAC) - May 2012, $5.00 strike puts: Sell for $0.55 per share.

Scenarios:

1. About a 12% total return if the stock expires without getting put to you over about a 5 month holding period.
2. You buy the stock (if it gets put to you) for a net $4.45 per share.

Berkshire Hathaway B (BRK/B) - January 2013, $75.00 strike puts: Sell for $7.05 per share.

Scenarios:

1. About a 10% total return if the stock expires without getting put to you over about a 13 month holding period.
2. You buy the stock (if it gets put to you) for a net $67.95 per share (below where Buffett is buying back shares)
   

Harvest Natural Resources (HNR) - June 2012, $7.50 strike puts: Sell for $1.75 per share.

Scenarios:

1. About a 30% total return if the stock expires without getting put to you over about a 6 month holding period.
2. You buy the stock (if it gets put to you) for a net $5.75 per share.
   

The risk with all of these is that the price goes below what your net purchase price would be, at which point the stock could get put to you and you'd have to buy at a net price above the market price. The key is to make sure it is a stock you'd like to own at that net price after taking into consideration that a lot may change between when you sell the puts and when they expire, and that illiquidity may make it hard to reverse your position if you change your mind without taking a big loss. The put prices will likely be much more volatile than the stock price, but they can actually be a lower risk trade if you can handle the mark-to-market volatility and they can be a good way to try and enter a stock at a lower price, as Warren Buffett did with some of his acquisition of Burlington Northern shares prior to buying the entire business.

It is worth keeping in mind that selling puts is usually much more attractive when the VIX is a lot higher than it is now, as the formulas that (non-value) investors use to value puts include volatility as a variable in that calculation. As an example, puts that expired 13 months out on Sears during the 2008 crisis yielded about 100% on the secured cash towards the end of 2008 and early into 2009 when the stock was at a similar price to its current one.

Neither I nor any investment product I co-manage have sold puts on the stocks mentioned in this article. The company where I work - Chanticleer Holdings, Inc. - has just launched a registered investment advisor, Chanticleer Investment Partners, LLC. This entity will start accepting outside capital next month and at least one of the strategies will consider selling puts when the situation is attractive. More details on this entity will follow within a couple of weeks.

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