Buy Write Combinations: An Almost Unknown Technique (That Shouldn't Be Unknown)

What is a buy/write combination anyway? This is what you get when you purchase a round lot of stock (any multiple of 100 shares) while selling both a covered call and a naked put on that same underlying security, typically using identical expiration dates. You BUY the shares, then WRITE the options. When executed in a margin account with plenty of free buying power the money collected from the two option sales can be used immediately to help pay for the shares purchased. That lowers the net cash outlay significantly while also providing a nice margin of safety compared with simply going long the stock. What is the key takeaway about using buy/write combos? Compared with simple share purchases only, you generally have less risk yet more upside. The first job is identifying a stock you think is poised to go up over time. On August 20, 2020 that is how I felt about Signet Jewelers , with the shares then at $13.46. SIG was very depressed in price back then due to Covid-related store closures and general market malaise. Here is the buy/write combo I recommended to readers at that time. The first section detailed the cash flow on a 1000-share purchase along with the sale of 10 contracts each of SIG's Jan. 21, 2022 expiration date $15 strike price calls and puts. SIG's high volatility and high market uncertainty allowed me to offset all but $2,060 of my original cash outlay via the option sales. Achieving the best-case scenario only required Signet to rise to $15 or higher by expiration day. As things turned out, that occurred quite quickly. The returns listed below assumed the entire position would be held right through expiration in January of 2022. Because SIG rose rapidly, however, I was able to close out the entire combination way ahead of schedule. Details on that will follow shortly. Trades can never be guaranteed to work as expected. You always want to know your worst -case scenario before committing. On the listed transactions break-even on the entire package protected me down to $8.53 per share. That provided a full 36.6% of downside protection versus the trade inception price. Fast forward 101 days from my combination's inception date. Signet had already risen to $31.19, way above the $15 strike prices employed. I could simply have waited another 14 months or so and ended up with the full $12,840 best-case scenario's maximum profit. Instead, I closed out each of the three legs early. That involved selling the SIG shares while also buying to close (BTC) both sets of options. The graphic below detailed those exact trades. I netted an $8,680 total return plus freed up my capital for the next promising trade. Those numbers came on a very nice run-up of 131.7% in the underlying shares over the identical time period. What made the buy-write combination so much more effective? It was the result of the leverage factor. I made an $8,680 gain on a much lower net cash outlay than would have been required to simply buy and hold 1000 SIG shares, sans options. Are there any readers who wouldn't have been thrilled to see a gain of greater than 421% over just 101 days? What has happened to Signet since that December 2020 close-out? Fundamentals have gotten much, much better. EPS surged from $2.11 in FY 2021 to a stunning $12.28 in FY 2022 (FYs end on the Saturday closest to Jan. 31 of the following year). Dividends were suspended during the Covid-panic but reinstated in September 2021, at $0.18 quarterly. That was raised to $0.20 quarterly recently. The stock went as high as $111.92 last November before falling back to as low as $48.31 on May 24, 2022. There was absolutely no bad news to justify that decline. In fact, Q1 2022 came in well above analyst estimates and management guidance was raised to a mid-point of $13.09, indicating all-time record results are projected this year as well. Traders pushed SIG to almost $70 on that news last Thursday morning before the DJIA's 880-point selloff on Jun. 10 took SIG down with everything else. At last week's close of $61.67 SIG was offered at just 4.7 times its FY 2022 guidance while paying a 1.3% current yield. What a great second chance to get back into Signet! New buy/write combos out to Jan. 19, 2024 starting looking fabulous as well. The graphic below shows actual pricing on SIG's $70 strike price options as of 4 p.m. on June 10, 2022. Here were the cash flow details in setting up a new buy/write using those $70 strike prices. If held through expiration there are just two possible outcomes. SIG will close at $70 or above, or below $70. If the former event unfolds, which appears highly likely, the following best-case scenario would play out. Any upturn of 13.5% or better would translate into a 256.6% total return. The annualized rate would be 159.4% due to the greater than one year holding period. Who wouldn't sign up for that right now if you were confident it could be achieved? 159.4% annualized will double your money in less than six months (pre-tax). What if SIG fails to reach and hold $70 by January of 2024? Barring a major decline you'd end up with a double-sized position at a net average cost of just $44.46 per share. That would hardly be scary knowing SIG earned over $12 per share in 2021 and appears set for better than that in 2022. Any decline of less than 27.9% from the trade inception price would allow for immediate liquidation for at least a small, and perhaps a quite large gain. What is Signet Jewelers really worth? Here is what three mainstream financial services thought about that as of June 10, 2022. Yahoo Finance took a very conservative view when projecting a 12-month goal price of $99.50. Research house Morningstar called SIG a 5-star (highest ranked) buy. They noted their present-day, not year ahead, fair value calculated to $112.93. Fast Graphs was the most bullish of the trio. It holds out a Jan. 31, 2023 potential north of $151 and a winter of 2024 price target for SIG above $194. No matter who you believe will be most accurate it seems clear that Signet is worth significantly more than its current quote. Don't miss this extraordinary chance to buy on a major pullback, which is totally market-related and detached from company-specific news. Buy some SIG shares, sell some SIG puts or consider setting up full buy/write combinations. Note: This article has been updated from an earlier version.

Buy Write Combinations: An Almost Unknown Technique (That Shouldn't Be Unknown)

This is an extraordinary chance to buy this stock on a major pullback which is totally market-related and detached from company-specific news.

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