Wednesday, June 12, 2013

Recent Option Transaction

Well the markets have started to waffle a bit which is good for those of us looking to acquire stocks.  Recently Caterpillar has sold off again to the low $80's thanks to concerns of slowing growth in China.  The forecast was downgraded to a "meager" 7.50% from 7.75%.  So in other words a rounding error as far as I'm concerned.  There's too much that goes into predicting the growth of a company or a country for that matter to be all that accurate.  With the weakness in Caterpillar, I took the opportunity to sell a put option to either added income or to get a very solid entry price.

I sold an $80 strike put option that expires November 16, 2013 for $4.15.  After commission and fees I received $406.26 in option premium right now to do with as I see fit.  The put option can work out one of three ways.

(1)  If CAT is trading above $80 on expiration, I'll get to keep the full option premium as profit.  This would be a $406.26 / $8,000 = 5.08% return, good for a 11.73% annualized rate through expiration.

(2)  If CAT is trading below $80 on expiration, I'll be forced to purchase 100 shares of CAT for $80 each.  Since I received the option premium I get to back that out from my cost basis which would become $80 - $406.26 / 100 + $7.95 / 100 = $76.02.  Based on the current annual dividend of $2.40, these shares would carry a 3.16% YOC and would provide $240 in annual dividends before further increases or reinvestment.

(3)  If CAT shares climb higher between now and expiration I can close out the position for a profit less than in case 1.

I sold this option on margin so my cash outlay isn't the full $8,000 but instead only $2,136.  Selling puts on margin allows for less capital to be required to maintain the position in order to avoid the dreaded margin call.  Although it's very easy to put yourself in a position where you're over-leveraged at exactly the wrong time.  I currently have 6 open put options and if they were all executed today I would be short around $7,600 although there's only 2 that are currently in-the-money and therefore able to be executed which would cost $13k.  My cash on hand is over $20k currently so I'd be just fine.  Most options aren't executed early and 4 of my puts won't expire until September or later.

Overall I feel this is a great put option.  I'll get a solid return if it expires worthless or get a great entry price if it's executed.  The average analyst 1 year price target is $96.90 per Yahoo! Finance, so this implies nearly over 25% of upside.  Earlier this morning, Caterpillar's board of directors announced a 15.4% increase in the quarterly dividend from $0.52 to $0.60.  I'm taking this as a sign that management believes all is still right with the company and the global economy as a whole.  If you expect results to lag you're not going to increase the dividend 15%, it would have been closer to 7-8%.  At least that's how I see it.

With the dividend increase this will add an extra $13.29 in annual dividends from my current position in CAT and brings the YOC up to 2.89% with a YOP of 2.93%.

I've updated my Option Summary and Portfolio pages to reflect this change.

8 comments:

  1. I finally got my mind to work with the call option but Im not sure I would do the put options. I just don't understand it enough and my comfort level is not there yet. Seems like you stand more to lose with put options.

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    1. Thomas,

      The key is to not sell put options on a company that you're not comfortable owning. If you find a company you want to own shares of and with the right combination of strike price and premium to give you a cost basis that you would be buying anyways then you're essentially setting a limit order to purchase, except you can earn a return if the limit order doesn't hit. You can lose more with put options because the stock could nosedive 10% one day and then executed early leaving you in the hole. However, I think a lot of that is mitigated by company selection once again. Don't sell puts unless you want to own the company.

      Selling call options is a very conservative strategy but one that I don't like to employ unless I'm trying to exit a position. There's a reason that I purchased shares in the first place so I don't want to risk having to sell them unless I want to get out.

      Thanks for stopping by!

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    2. Thanks so much for the clarification! And you are welcome! Great post!

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  2. Wow. I've wanted to add more CAT and this is the way to go. Unfortunately, my brokerage firm does not offer cash covered puts and has refused my application for naked puts. All the best to you.

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    1. ADY,

      That's a shame that you can't get that approved for your account. Although there's nothing wrong with sticking the the tried and true DCA method that you have.

      Thanks for stopping by!

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  3. PIP,

    Your interest in and explanations of selling options have been very helpful, and inspired me to start selling calls as well. I've been jumping through hoops with my broker (Scottrade) to open an options account, only to get "Unable to enter the order because selling puts to open is not available at Scottrade" when I finally go to place the order. Incredibly frustrating.

    Who do you broker with to trade options?

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    1. Michael D,

      Glad to hear that I've helped. Selling calls is another great way to earn extra income. I don't typically use them since I don't want my shares called away since I usually purchase at what I feel is good value. I much prefer selling puts, but you have to be willing to own the company.

      I've heard that about Scottrade, although I do like their new flexible dividend reinvestment program. That's a great idea. I use Fidelity, although that's mainly out of convenience because there's lower cost options out there. I've heard good things about OptionsExpress but haven't ever gotten around to researching their fee structure yet.

      Thanks for stopping by!

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    2. Oops, typo, meant to say selling puts. I agree, I'm interested in owning these companies anyways, and selling puts would let me earn a little money waiting for the right price. But Scottrade just doesn't seem to offer that service (though it's obnoxiously an available option in the order process), and now I'm shopping for new brokers. I'll check out those suggestions, thanks a lot!

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