One of the practical applications of selling cash-secured puts is to buy shares “at a discount” In my books and DVDs I use out-of-the-money puts in lieu of setting limit orders in order to accomplish this goal. Some of our members have inquired about using deep in-the-money puts (strike well above current market value) instead of out-of-the-money strikes in order to both buy a stock at a discount and capture additional premium as well. Let’s break this down the Blue Collar way to see if this approach should be in our arsenal. I am using Michael Kors Hldgs Ltd. (NYSE: KORS) trading at $44.15 at the time I am writing this article and we will review 5-week returns.
KORS option chain as of 9/14/2015 (puts and calls)
Let’s compare the deep in-the-money $50.00 strike with the out-of-the-money $42.50 and $40.00 strikes (all highlighted in brown) using the BCI Put Calculator:
The deep in-the-money $50.00 strike creates an opportunity to purchase KORS at a minuscule discount of 0.34% whereas the out-of-the-money puts generate much more significant discounts of 6.80% and 10.99%. Now one might inquire about the huge unexercised return of 13.64%. In order to generate that return, share value would have to move from $44.15 to above the $50.00 strike, possible but unlikely. If we are that bullish, I would prefer out-of-the-money covered calls highlighted in yellow in the left side of the options chain shown above. Here are the calculations from the multiple tab of the Ellman Calculator:
Including upside potential (price movement from current market value up to the respective strike) the $45.00 and $47.50 strikes offer potential 1-month returns of 5.5% and 9.2%
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The best way to buy a stock “at a discount” is to sell out-of-the-money puts. The deeper out-of-the-money we go, the greater the discount but the less likely for the options to be exercised. If unexercised, however, we still generate a nice return from the put premium. If bullish, look to incorporating out-of-the-money call options into our strategy.
Option Liquidity and our Premium Stock report
A few of our new members have inquired about the open interest column in our Weekly Stock reports. First, let’s have a look:
The column circled in red reads “NTM OI > 100 Cntr.” This stands for near-the-money strikes with open interest of more than 100 contracts. A “Y” means that at least one NTM strike meets the guideline; an “N” means that no NTM currently has more than 100 contracts. The blue arrows (HELE and CATY) point to the latter situation. The question we receive periodically is why do we include stocks like HELE and CATY? There are two reasons we include such securities:
- Option liquidity which is measured after market close on Friday can change during the week and perhaps meet our guideline of > 100 contracts and/or a bid-ask spread of $0.30 or less
- We have a significant number of members who also use these lists for the “stock only” (no options) portion of their portfolios
By including “Y” or “N” in the OI column, it is time efficient to either consider or reject these securities.
Blue Collar Scholar Competition:
Contest leaders as of Friday’s market close (S&P 500 reading at the end of the year)
Sample Commentary from Dagmar:
“The weekly chart of the S&P 500 is in an uptrend, the monthly chart is reversing up and resistance is the previous all-time high. Usually, from October to December and into Christmas, the market sees an uptrend”.
Next live appearance
Saturday January 23rd, 2016: Kansas City, Missouri
9 AM – 12:30 PM
Matt Ross Community Center
US stock indices were flat for the week, reflecting the mixed economic data of the week. The CBOE Volatility Index (VIX) dipped below 17 after reaching 19 on Thursday. This week’s reports:
- US nonfarm payrolls increased by 211,000 in November, and revisions added a total of 35,000 jobs to the September and October stats. With the revision, October’s payrolls grew 298,000
- The unemployment rate was flat at 5.0%
- The U-6 broad measure of unemployment, which counts those in part-time jobs and those who have given up looking for work, moved up to 9.9%
- Average hourly earnings grew 0.2% in November and rose 2.3% year-over-year.
- The Institute for Supply Management’s gauge of US manufacturing activity fell to 48.6 in November from 50.1 in October, contracting for the first time since 2012 and the weakest reading since June 2009
- The ISM index of nonmanufacturing activity fell to 55.9 in November from 59.1 in October
- New orders, employment, backlogs and export orders all dropped although the US service sector has grown each month for nearly six years
- US nonfarm worker productivity increased 2.2% in the third quarter, down from 3.5% in the second quarter
- Employees worked 0.3% fewer hours, while unit labor costs rose 1.8% and real hourly compensation was up 2.4%
- US auto sales topped an 18 million annual rate for a record third straight month in November. At this pace, the industry is set to shatter in 2015 the 17.35 million mark set in 2000. November’s sales were up 1.4% from a year earlier assisted by cheap gasoline and low financing
- The US trade deficit widened 3.4%. Exports fell 1.4% and imports declined 0.6%. The decline in exports stems from weak demand abroad and a strong US dollar. Imports have slumped largely because of lower costs for oil and food
- Initial jobless claims rose 9,000 to 269,000 for the week ending November 28th
- Jobless claims remain near 40-year lows
- Continuing claims rose 6,000 to 2.16 million for the week ending November 21st
For the week, the S&P 500 rose by 0.08% for a year to date return of 1.59%.
IBD: Uptrend under pressure
GMI: 3/6- Buy signal since market close of October 19, 2015
BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. I remain fully invested using 50% in-the-money strikes until the Fed makes its position on interest rates known and evaluating the ensuing market reaction. I believe that most institutional investors have factored in a 25 basis point rate hike with moderating guidance for the December Fed meeting.
Wishing you the best in investing,