Nike In-the-Money Naked Put Sale

Summary: On 12/17, I sold 2 Nike $70 Puts, expiring January 2012, for a credit of $3,040, less commissions. In connection with the sale, my brokerage account reserved $5,573. If exercised, I will be required to make a $14,000 purchase.

Max Profit: Max profit on this in-the-money naked put sale is the amount of premium collected, $3,040, less commissions, which will occur if Nike (ticker symbol: NKE) is at or above $70 per share at expiration.

Max Loss: Max loss on the position is $14,000 less the $3,040 premium collected, or $10,960, which would occur if Nike stock went to $0.

Break-Even Point: Break-even point, ignoring the time value of money (I've collected the premium in advance), is $54.80 per share at expiration, which is roughly 13% below Nike's price on 12/17.

Rationale: Nike, one of the great American brands and companies, has delivered terrific revenue and income growth rates as well as returns on assets and equity over the last twenty years, and shows few signs of slowing down. The company has great international opportunities, is conservatively capitalized with very little debt and excess cash, and spits off a tremendous amount of cash which can be used for acquisitions, stock buybacks and dividends. Trading at around 21x trailing earnings and 16x forward earnings, Nike isn't unreasonably expensive, but above a price at which I'd consider the stock for an outright investment. By selling long dated in-the-money puts with a good amount of extrinsic value (13%), I can target a much cheaper purchase price in the distant future for a stock I'd like to own, while taking part in a substantial amount of upside in the event Nike's stock continues to rise. (Note, however, that this 13% figure should be discounted by dividend payments, which are currently 1.08 per share.) If, as predicted by analyst and management, Nike experiences continued revenue and earnings growth, an effective purchase price of $54.80 in two years would be substantially cheaper than $54.80 today. Analyst are predicting diluted EPS for the fiscal year ending May 2011 of $4.10, which would make an effective purchase price of $54.8 13.7x earnings, far below Nike's historical multiple of trailing earnings, and a multiple at which I'd be glad to purchase the stock. In addition, this position requires little investment on my part - reserved cash of around $5,573 less the put premium of $3,040, or $2,533. If Nike were to simply stay at its current price until expiration, my investment return would be roughly 68%. (Note that for simplicity's sake, in calculating returns I am assuming that reserved cash stays stagnant over the life of the call. In reality reserved cash increases with a decline in the price of the stock and decreases with an increase in the price of the stock. If Nike stock declines substantially prior to expiration, this position would effectively require more investment in the form of reserved cash.)

In the event Nike stock continues to rise prior to expiration, I will repurchase the put and take gains on the position when I believe risk outweighs any additional reward. In the event Nike stock declines substantially prior to expiration, I will likely sell additional puts for more premium. Note that fundamentally this position reflects a long investment in a stock and company I feel strongly about over the medium to long term.