Tuesday, March 12, 2013

Recent Transaction

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.


7 comments:

  1. Congrats on your first margin trade JC! I believe this is a great trade and either ending wouldn't be a wrong move! I have been eyeing LO myself for quite awhile. Doesn't hurt they just announced last week a $500M stock repurchase over the course of 2013. I think this will provide some tremendous value in addition to the great dividends being paid.

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    1. W2R,

      Thanks. The opportunity no matter how the trade turns out was a little to good to pass up since I don't think anything will come of the menthol ban. That share repurchase program will help to prop up the stock price too. I'm not sure how I'd like this to work out, probably have the stock close at $0.01 below the strike so it's in the money but I get a big discount on the shares from the premium. I'd like to be able to juice up my yield some more and this would go a long ways towards helping with that. Although I don't think that's how it will play out, I'm expecting it to either expire out of the money or that I buy it back early.

      Thanks for stopping by!

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  2. Nice trade. I started using margin earlier this year to purchase CSX and then sell a call on those shares. I think the important thing is to have cash on hand incase of a margin call. I want to be able to buy if the market/stock crashes, not sell to cover a margin call. It was a wise move to educate yourself before using margin; it scared a lot of retail investors back in 2008 & 2009.

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    1. ADY,

      Having the cash quickly available is very important if you want to avoid a margin call. And most brokerages have the right to sell any shares in your account to be able to meet the margin call, so they probably won't be doing it the way you would. I figured it was pretty simple to understand but I hadn't ever really looked into it. I'm glad I did because my put selling will net me more option premium than going the cash secured route since I can use a bit of leverage.

      Thanks for stopping by!

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  3. Great trade to make. I may consider something similar, I've been looking at Lorrilard for a while now and waiting for it to drop back down but am not sure that's going to happen in the near future.

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    1. I'd was very close to just purchasing LO outright, but decided on the put instead. If I had my choice it would be trading just under the strike on expiration and I'd have the shares put to me for a big discount. I expect there to be a bounce back up after the menthol ban talks die down.

      Thanks for stopping by!

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