Thursday, October 24, 2013

Recent Option Transaction

I had a recently executed call option on some HAL shares last Friday and the capital from that transaction plus the capital that I've been able to save from my job has led to a fairly sizable cash position for my portfolio.  I'm sitting around 10% cash now and there's just not a log of bargains that I see in the market to really get my mouth watering.  To be fair there's plenty that are hovering around the fair value price points from my stock analyses, but nothing that I'm excited about.  The way I see it, I have two options.  Wait for Mr. Market to give some better prices or you guessed it, turn to the options market.

It's been a long time since I've been able to venture into the options market as capital had been tight due to the house purchase and better opportunities to make outright purchases.  I decided to sell a put option on Cisco with a $22 strike that expires on December 21, 2013.  In exchange for selling the put option I received $0.79 per share or $79.00.  After commission and fees the total premium came to $71.01.  This option can work out one of three ways.

(1) If shares are trading below $22 on expiration, then I'll have to purchase 100 shares of Cisco for $22 each.  However since I received the option premium I get to lower my cost basis by that amount giving a final cost basis of $21.37 per share.  This cost basis would be at a 3.6% discount to my target entry price.  Based on the current annual dividend of $0.68 per share these shares would carry a YOC of 3.18%.

(2) If shares are trading above $22 on expiration, then I'll get to keep the full option premium as profit.  Based on the $2,200 in capital that's at stake that would represent a 3.23% return in just under 2 months, good for a 20.31% annualized return.

(3) If shares of CSCO make a sharp move higher then I can buy to close the put option and receive a profit less than in case 1.

I mentioned in case 2 that $2,200 in capital is at stake.  That's not entirely true as I sold this put option on margin, or a naked put option.  A naked put option essentially uses your margin account as a line of credit and allows you to hold less capital than if you used a cash secured put.  In this case, the capital that I have to keep on hand in order to secure the put option and avoid margin interest is just $606.87.  While I have the cash on hand to have done this as a cash secured put, the naked put option using margin is very useful as less capital is required to hold the position and should the markets take a dip and I can use more cash to purchase shares.

I'm bullish on Cisco in the long-term even though I try to stay away from technology companies, of course you couldn't tell that by my recent IBM purchases.  Cisco's plan for growth is through innovation and creating an "Internet of Everything".  With more and more mobile devices coming online every day and the need for more and faster data, Cisco's IoE plan should capitalize on the data consumption that so many of us crave.

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


  1. Nice trade JC! I am on board with you and agree that Cisco's got a great plan ahead of them, both from a business perspective, and a shareholder perspective. They are showing they are willing to return cash to the shareholders, and grow that return, while pursuing the IoE plan.

    1. W2R,

      There's some good potential ahead for dividend growth which is my main concern. This trade gives a solid return if shares trend higher and what I think is a good starting price for a company with the potential for some really good dividend growth. Time will tell. Although I've been successful with some CSCO puts so far in collecting premium, I wouldn't mind picking up a few shares.

      Thanks for stopping by!

  2. JC,

    What is your preferred outcome for this scenario? Is acquiring the shares at $21.37 your best case scenario?


    1. RBD,

      I'm fine either way it works out but I'd probably lean towards the option just expiring. CSCO is one of those new dividend payers, and while a 25 year streak has to start somewhere, they haven't even been paying a dividend for 3 years yet. I wouldn't be opposed to acquiring the shares though and giving them a shot. The potential is there to be continue growing the dividend. Solid plan for growth of the company, low payout ratios, undervalued by most metrics, over $9 per share in cash as of the last quarter ($6+ in net cash). Heck that's around 40% of the market value in just cash on hand. I'm still trying to limit my tech exposure but I'll be fine with picking up some shares and giving it a go.

      Thanks for stopping by!