More Buy/Write Magic With Steelcase

The key to any buy/write combination is selecting a good underlying stock. That means identifying shares with both a high probability of moving higher and a low risk of a major decline. Under-followed office furniture manufacturer Steelcase Inc. seems to fit that bill. The firm saw its best EPS ever in 2018. Per-share revenue, cash flow and dividends all increased, as well. Analysts see further all-time records on tap in 2019 and beyond. Despite all those positives, SCS closed Mar. 29 at just $14.55, down from a peak of $19.35 last September. SCS traded at $17.92 as recently as Feb. 22. After dipping to $14.55, Steelcase yielded a generous and well-covered 3.99%. Since 2011, SCS has averaged about a 15.7x multiple, accompanied by about 3.02% in current yield. A reversion-to-the-mean valuation would support a 12-month target price north of $19. That's better than a 31% move from here, plus dividends. That goal, if anything, might prove too conservative. When Steelcase has been popular, it tended to peak at between 18x and 21x earnings (red-starred above). Owning SCS outright should work out well. Using SCS as the basis for a buy/write combination might be even better than simply purchasing. Buy/writes involve owning round lots of an underlying stock while selling both covered calls and naked puts on the same stock and using the identical expiration date. There are many permutations available, depending on how bullish you might feel. The illustrated trades, below, represent a very conservative use of this fine technique. Here were the Oct. 18, 2019, expiration date prices from the close on Mar. 29, 2019, with SCS at $14.55. The numbers in the table, below, reflect trades executed in a margin-type account, with adequate free buying power to secure the put options. Money received from the two option sales helped pay for the 1000 shares purchased, lowering the out-of-pocket cash needed. At 4:00 p.m. ET on expiration day, there are only two possible outcomes. SCS will either be $15 or higher, or below $15. Obtaining the best-case scenario only requires a 3.1% move higher from the trade inception price. That very modest upturn translated into a fine, 30.68% cash-on-cash return in just 202-days. Outright buyers of SCS would need to see $18.72 per share by Oct. 18, 2019, to see the same percentage return. The duration of the trade is just 202 days. Earning 30.68% in just a bit more than half a year is equivalent to an annualized rate of almost 55.5%. There's no guarantee that Steelcase will be at least $15 on expiration day. The worst-case scenario detailed below would play out if that is what occurs. Investors who found themselves in this scenario would need to pony up an additional $15,000 when put. They would end up owning 2,000 shares of SCS at an average net cost of $13.21 per share. The $1.34 per share margin of safety means Steelcase could drop by up to 9% while still allowing for a profit on the entire buy/write trade. It's nice to know that you could be somewhat wrong on your prediction yet still end up making money. I've detailed the potential gains and risks involved using SCS's Oct. 18, 2019, expiration $15 calls and puts. In real life investing, it might be more advantageous to buy shares and sell puts with the stock depressed, while waiting for a rally before writing the covered calls. Traders might even want to sell $17.50 strike calls rather than $15s to try for greater upside. Steelcase is a hidden gem. Playing it via a buy/write combination reduces risk while capturing most, or all, of its expected potential gains. Buy some shares, sell some puts or consider going with the entire three-part combination.

More Buy/Write Magic With Steelcase

Investors can use a buy/write combination to take advantage of Steelcase's upward mobility while also buying some protection should the office furniture maker's stock price go south.

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