Yesterday I sold a put option on Lorillard (LO). Lorrilard's share price has been under pressure recently due to the talks of a potential ban on menthol cigarettes. I don't feel that the menthol ban will ever go past just talks and would like to own another cash cow cigarette company. Lorillard would be a great addition as they are a dividend challenger with a 3 year dividend growth rate over 17%.
I sold the May 18th $37.50 put for $1.30. I chose the $37.50 strike because it is currently out of the money, offers a very compelling option premium and will give a great YOC based on the current dividend payout. Plus it doesn't hurt that if come expiration date the option is expired I'll have the shares in time to collect their next dividend payout since typically their next record date is at the end of May. By selling the put option I received $1.30 * 100 - $7.99 = $122.01 in option premium now to use as I see fit.
The trade can turn out in 1 of 3 ways.
(1) If LO is trading above $37.50 on May 18th, I will get to keep the full $122.01 as profit. This would represent a 3.25% return in just over 2 months which represents a 17.46% annualized return.
(2) If LO is trading below $37.50 on May 18th, I will be forced to purchase 100 shares of LO for $37.50 each. Of course I get to back out the option premium in my cost basis as follows $37.50 * 100 - $122.01 + $7.95 / 100 = $36.36. Based on the current annual payout of $2.20 per share, this would be a 6.05% YOC.
(3) If LO makes a big move up in price I could close out the trade prior to execution netting a return less than the $122.01.
Overall I'm happy with how this option can play out. I'd like to own another solid DG stock and think the menthol ban won't be an issue going forward meaning it's just short term noise causing a very good entry point for investors.
This is also my first trade that I've done on margin. Since I'm using margin I don't have to hold the full $3,750 in my account to cover the put, although for this first one I will be keeping the total funds there as a precaution. My current margin requirement, the cash needed to maintain the margin account and avoid a potential margin call, is $1,003.25. For an explanation of what margin is and how it works check out this post.
I've updated my Option Summary page to reflect this trade.