Rick's Cabaret International Puts

Summary: On 10/28, following a severe decline in the price of Rick's stock (RICK), I sold 10 December 2009 7.50 puts, for a net credit of $1,100. At the time, the puts were slightly in the money. Because these are "naked" puts, a brokerage will require cash collateral in the event of exercise, which as of 10/30 was $2,537.

Rationale: Rick's, the owner of several "adult nightclubs" (strip clubs) is a stock I follow and have long thought to be a good investment if purchased at an appropriate price. It trades at a low multiple of earnings (which as of 10/30 was roughly 7.5x predicted forward earnings) and generates strong free cash flow. Rick's is a consolidation story - it acquires clubs generally at low multiples of earnings (likely possible given the lack of buyers and general unsophistication within the industry), which are, in most cases, immediately accretive to earnings (there are exceptions - the company acquired the old Las Vegas Scores at a hefty price and which has since been a losing investment). In the event the puts are exercised, my effective purchase price would be $6.4 per share ($7.50 less the $1.10 premium). This price would value Rick's equity at less than 7x forward earnings, a multiple I believe more than prices in the past year's lackluster earnings and liquidity scare (which has since abated) and the current economic environment, and would present a favorable risk/reward scenario to go long the stock. After purchasing the stock, I will look to sell calls against my holdings so long as I can capture favorable premium at an appropriate price. If the puts are not exercised, and Rick's stock closes above $7.50 per share as of the December closing, the captured put premium would represent a roughly 17% real return on the cash required to purchase Rick stock, less the put premium, over a two month period, and obviously an even higher return on my actual reserved cash. Note that given the possibility of exercise, I do not find it appropriate to calculate return on this investment using merely a brokerage's margin requirements as the amount invested.