Would You Settle for Close to 25% Annualized?

Most investors would kill for returns like the one in my headline. When I show them a way to do that, however, they often shy away. Why is that? They don't truly understand the power of buy/write combinations. Buy/write combos employ going long on shares of stocks while shorting both covered calls and naked puts on the same stock, typically with identical strike prices and expiration dates. The most critical aspect of setting these up is selecting an underlying stock, which is very likely to trend higher over the period of the trade. Good quality, dividend-paying shares of growth companies make for sound choices, especially if they are reasonably priced. CBOE Global Markets, Inc. appears well suited for this type trade right now. The firm came public on Jun. 15, 2010, priced at $29. It closed that day at $32.49. Few companies have done better since then on a fundamental basis. From 2010 through 2018, all major metrics improved dramatically. Long-term shareholders have to be satisfied with total returns of more than 207% in just under nine years. That said, CBOE peaked at $138.50 in January of 2018, perhaps on Bitcoin mania and the prospects of huge profits from speculators trading on cyber currencies. Firms this solid, with proven growth records, rarely sell cheap. CBOE's average multiple has been 23.5x, accompanied by around 1.44% in yield. That old all-time high reflected over enthusiasm, at 36.8x forward earnings, along with a decidedly sub par yield. As of Apr. 8, 2019, CBOE, @ $95.80, looks to be slightly under priced. A regression-to-the-mean valuation bounce on Value Line's EPS estimate of $4.50 could easily take the shares back to north of $105 by year-end 2019. Note, too, that Yahoo Finance shows a higher consensus view, at $4.84 per share for 2019, rising to $5.36 in 2020. Reaching my 12-month goal would provide about 11.7% in total return for those who simply buy shares outright. That's good, but not the kind of upside that gets your heart racing. After pulling back from last year's peak, CBOE appears poised to resume its upward trajectory. Over its entire trading history, CBOE shares did better than 95% of the 1700 companies covered in Value Line's main research universe. The company has never posted a non-record year. Dividend rates were increased without fail. CBOE is an odds-on bet to be higher over time. That makes it a fabulous choice for our conservative buy/write combination. The table below shows the actual bid/ask spreads for CBOE's Jan. 15, 2021, expiration date options with the stock @ $95.80. I chose to use the $100 calls and puts in order to capture a modicum of upside in addition to the premium income coming in from the two option sales. The combo could be tweaked to become more aggressive if desired. When executed in a margin account, with adequate excess buying power, the out-of-pocket cash is reduced by using both call and put premiums to help pay for the shares being acquired. If all three positions (long stock, short call, short put) are maintained through expiration, there are only two possible outcomes. CBOE will finish at $100 or higher, or below $100. The first scenario would represent the best case, detailed below. Any increase of 4.4% or greater would result in a cash-on-cash total return of more than 45%. Over the 647-day duration, that comes to 25.4% annualized. Turning a less than 5% gain on the underlying shares into that hefty figure sounds pretty exciting to me. ***************************************************************************** There's no guarantee CBOE will close above $100 on Jan. 15, 2021. If not, the following worst-case scenario would play out. This prospect, unlikely in my view, would still be far from scary. The average cost of the 200-share final long position would be $11.68 per share below the trade inception price. That represents a 12.1% extra margin of safety versus outright purchase. Future stock market action can never be guaranteed. We can know for sure, though, that owning CBOE at $84.12 would have been a winning position 100% of the time dating back to June of 2017. Outright owners of CBOE would need to see their shares hit about $138 to pocket the same percentage gains as investors who executed the entire buy/write combination. Plus, they would have had no protection if CBOE had declined instead of advanced. All in all, this combination shapes up as a low-risk, high-return proposition.

Would You Settle for Close to 25% Annualized?

Investors should consider a buy/write combination in order to take full advantage of the growth of CBOE Global Markets' stock price, while also building in some insurance against a move to the downside.

Columnist Conversation

My Take on the FOMC Decision

GS Chart Updated

Still a Bid for NO Cut This Week

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.