The December 2011-January 2012 period was one of my best ever for option expiration bets. I had sold put options and combinations on several cheap stocks last year, and most of them expired worthless. Stocks such as Research In Motion (RIMM), Skechers (SKX), Micron Technology (MU) and Sterling Construction (STRL) all rallied enough to stay above the strike price, and I collected some pretty fat premiums for my cash-secured puts. On my combination trades, I got put some additional shares of Royal Bank of Scotland (RBS), which then rallied leaving me with fairly large profits after considering the collected premiums. Since meeting the thoroughly disreputable crown of Chicago options traders earlier this century, options have become an increasingly useful and profitable tool for deep-value-based investing.
The majority of the options trading I do is selling cash-secured puts. I sell puts on stocks that I want to buy at the current price or lower and post 100% margin, so my risk profile is exactly the same as selling a covered call. It is a low-risk way to generate profits on value stocks that often linger at lower prices before the market provides a catalyst for higher prices. It can also help me back into stocks at lower prices when the market falls and the shares are put to me at the strike price. In that case, the premiums collected help me reduce my overall cost basis in the shares. The key to making this work is stock valuation. The shares have to be cheap and worth owning at the strike price before I even consider putting on a trade.
With so many positions expiring, I decided that I would look for some new candidates for my cash-secured put portfolio. The market has gone straight up and the VIX is currently trading below 20. That is not the best option-selling environment, so I will use caution and patience in opening premium-collection positions. When volatility does begin to increase and moves above 30, I want to be ready with a list of stocks and which strikes I want to sell. On the best days for selling options, there is rarely time to do the homework. On some of the stocks with very thin options markets, I like to calculate the price at which I want to sell puts and simply order good-to-cancel orders -- no matter how far away from the current market price the quote might be.
Let's start with a couple of stocks in which I want to renew my short put position. I am a huge fan of Sterling Construction. At some point in time, the Texas-based highway construction company is going to see a wave of spending on infrastructure projects fill its coffers. For now, the stock has been trading between $10 and $13 a share. The company has an enterprise value to earnings before interest, taxes, depreciation and amortization ratio of less than 3, and the balance sheet is solid.
It will be some time before we see heavy road and highways spending power the stock higher, so selling puts allows us to get paid while we wait. I want to sell the March $10 puts for $0.60 or better, according to my valuation and option calculations, so I am going to place an order to do so. We will need to see a sharp decline and volatility spike to get filled, but given the last year of market action, it is far from impossible.
The other expiring option I want to resell is put on Skechers. The company has been able to clear the excess inventory that plagued it throughout much of the past year. Skechers continues to expand internationally and has introduced new footwear styles and apparel that appear to be well received.
At the current quote, the stock trades at about 70% of tangible book value and at a small discount to my back-of-the-envelope liquidation value. I want to own the stock at a steep discount, so I am looking at selling the April $10 puts in a market or stock-specific decline. For now, I am going to put in an order for a small position to $0.60 or better, as a just-in-case order. This way, if I am out of the office or traveling when conditions are optimum for selling options, I will gain a small position.
Tomorrow, I will look at some new ideas for collecting premium and backing into cheap stocks at lower prices.