How Sweet It Is to Write Puts

Selling puts can be a glorious technique when performed correctly, delivering immediate income along with a margin of safety vs. an outright purchase of the same underlying stock. Writing puts means committing to the possibility of having to buy some multiple of 100-shares of a designated stock at a predetermined price, called the strike price. If the position is held to maturity, there are just two possible outcomes. You'll either keep all the money you collected up front, without needing to buy the stock, or you'll be forced to buy at a net price equal to the strike minus the per-share put premium collected. If you'd be happy owning a particular stock, at that net price, it's hard to feel bad, even if you do end up having to buy it later. The key to successful use of the strategy is identifying good underlying situations before committing. Here's an example. On Aug. 27, food maker J.M. Smucker took a big hit after reporting slightly below estimated earnings for its July 31 fiscal 2019 first quarter. Management trimmed full-year guidance, on adjusted earnings per share, or EPS, from a range of $8.45 to $8.65, to one of $8.35 to $8.55. That 10 cent full-year reduction represented just a 1.2% change. When a small news item begets a major sell-off, I often see opportunity. Since 2010, SJM typically traded for about 17.5-times current year's EPS. A normalized yield ran around 2.48%. As of 10:19 a.m. on Aug. 27, SJM was offered for just 14.8-times the already reduced estimate, accompanied by a 3.15% current yield. Excepting Smucker's Christmas Eve Capitulation of 2018, momentary low, that was close to the cheapest valuation on this stock since near its bottoms in both 2010 and 2011. Those were great times to buy. SJM was about to run from south of $54 in 2010 to north of $114 by late summer in 2013. It finally peaked at over $157 during the August of 2016. It doesn't seem far-fetched to think SJM can rebound to at least $120 by the end of fiscal 2019, which ends April 30, 2020. Smucker peaked well above that level during each of the previous five years including 2019 year-to-date. Buying SJM at $102.26 with an eye toward $120 by next April would net 17.3%, plus dividends over the coming eight months. There's nothing wrong with that. Suppose you lacked extra capital to deploy right now, but still wanted to play SJM on the drop. Selling some long-term puts might be a great way to play. I highlighted SJM's actual bid -- ask spreads and option premiums for the Jan. 15, 2021 expiration date puts below. The graphic shows the prices for its $100 to $115 strike prices. With SJM at $102.26, worst-case, forced purchase prices dropped to from $87.30 to $93.90, depending on the strike selected. The percentage between the net exercise prices and the trade inception price is called the margin of safety. That represents the maximum percentage decline from $102.26 (in this example) that could occur by expiration date without causing a loss for the put seller. Knowing you could be somewhat wrong on the direction of the stock's price, but still potentially make money, gives a nice feeling. If SJM is really worth $120 or better, it's hard to imagine it will end up below $94 in January of 2021. Matter of fact, Smucker's hasn't changed hands for less than $91.30 even once during the previous half-decade. SJM closed above $103 by the end of the day on Aug. 27. SJM spent the majority of those five years hovering between $110 and $130, a range well above all the if put prices on the puts shown. Maximum profits on these, or any other option sales, equal keeping 100% of the money received up front. For the examples shown previously that equates to from $1,270 to $2,110 per 100-share commitment. Don't fear options. Learn how they work and their use won't seem scary, at all. Selective put writing is a great tool to have in your investment quiver when the right opportunity presents itself. With these Smucker puts, you'll either end up pocketing over $1,200 for not buying SJM, or you'll own at least 100 shares at the best entry price in more than five years. Either possibility is likely to make you happy over time. I wrote this article in advance of its publication date; the company closed Tuesday up more than $3.50 from Aug. 27 to $107.18.

How Sweet It Is to Write Puts

Let's look at the joy of selling puts, using J.M. Smucker as an example.

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