Sunday, December 27, 2009
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.
Thursday, December 24, 2009
Some House Cleaning
Over the past several weeks I've made a number of trades in the account but haven't had a chance to post. Below summarizes a few trades I've made to close positions, and the returns for each of these positions. I also summarize a rolling trade made for a net credit last week. Later posts will summarize two new positions.
A-Power Generations Systems, Ltd. Naked Puts
On 11/3, I sold 10 March $10 APWR puts for a net credit of $1700. I entered the trade with the idea that if exercised, I would purchase the stock at an effective purchase price of $8.30 per share less commissions, a price at which I considered the stock to be a compelling investment. Alternatively, if the puts expired worthless, I was happy to collect the $1700 of premium. Since selling the puts, the stock ran away from me. On 12/17, I took the opportunity to repurchase the puts at $.30 per share, substantially before expiration. My net gain on the position was $1,349.95.
Including commissions, and taking into account the amount of cash necessary to purchase the shares upon expiration ($10,000), my real return on this investment was 16.22%, or an IRR of 247.85%. My return on the position taking into account just the reserved cash required by the brokerage borders on the absurd and isn't a particularly helpful number (this number will however be taken into account in determining my aggregate returns because it will presumably be offset by losing positions overtime).
Lockheed Martin Diagonal Call Spread
On 12/17, I closed out my diagonal call spread on LMT. I had originally opened this position on 10/15, before their Q3 earnings report by purchasing March 70 calls, and selling December 75 and December 80s. Following management remarks regarding a poor outlook, the stock dropped substantially, and I decided to ratchet down the position by buying back the December 80 calls and selling additional December 75s, for a net credit. In late November I then rolled the December 75s to January for a net credit. Subsequently, the stock steadily drifted upwards and on 12/17 I ultimately repurchased the January 75s and sold the March 70s. Ultimately, the position (actually multiple positions) resulted in a profit of $1,184.22, and an IRR of 142.3%.
Over the next several months, I will look to reestablish a Lockheed Martin diagonal call spread when an opportunity presents itself.
Buckle Diagonal Call Ratio Spread
On 10/23 I entered a diagonal call ratio spread by purchasing 6 June 25s and selling 4 December 30s. On 11/20, I added to the position by purchasing 6 more June 25s, and selling 5 more December 30s. Finally, on 12/18, I rolled the December 30s to March for a net credit of $1,627.91. This position is currently outstanding.
A-Power Generations Systems, Ltd. Naked Puts
On 11/3, I sold 10 March $10 APWR puts for a net credit of $1700. I entered the trade with the idea that if exercised, I would purchase the stock at an effective purchase price of $8.30 per share less commissions, a price at which I considered the stock to be a compelling investment. Alternatively, if the puts expired worthless, I was happy to collect the $1700 of premium. Since selling the puts, the stock ran away from me. On 12/17, I took the opportunity to repurchase the puts at $.30 per share, substantially before expiration. My net gain on the position was $1,349.95.
Including commissions, and taking into account the amount of cash necessary to purchase the shares upon expiration ($10,000), my real return on this investment was 16.22%, or an IRR of 247.85%. My return on the position taking into account just the reserved cash required by the brokerage borders on the absurd and isn't a particularly helpful number (this number will however be taken into account in determining my aggregate returns because it will presumably be offset by losing positions overtime).
Lockheed Martin Diagonal Call Spread
On 12/17, I closed out my diagonal call spread on LMT. I had originally opened this position on 10/15, before their Q3 earnings report by purchasing March 70 calls, and selling December 75 and December 80s. Following management remarks regarding a poor outlook, the stock dropped substantially, and I decided to ratchet down the position by buying back the December 80 calls and selling additional December 75s, for a net credit. In late November I then rolled the December 75s to January for a net credit. Subsequently, the stock steadily drifted upwards and on 12/17 I ultimately repurchased the January 75s and sold the March 70s. Ultimately, the position (actually multiple positions) resulted in a profit of $1,184.22, and an IRR of 142.3%.
Over the next several months, I will look to reestablish a Lockheed Martin diagonal call spread when an opportunity presents itself.
Buckle Diagonal Call Ratio Spread
On 10/23 I entered a diagonal call ratio spread by purchasing 6 June 25s and selling 4 December 30s. On 11/20, I added to the position by purchasing 6 more June 25s, and selling 5 more December 30s. Finally, on 12/18, I rolled the December 30s to March for a net credit of $1,627.91. This position is currently outstanding.
Tuesday, December 8, 2009
True Religion Apparel, Inc. Puts
Summary: Today I sold four True Religion Apparel, Inc. (Ticker Symbol: TRLG) July 2010 25 puts for a credit of $3,080.00, less commissions. Because the puts were sold "naked," my brokerage has reserved $4,602.40 of cash in my account. The net result of the transaction is a decline in my purchasing power of $1522.40.
Break-Even Point: Break-Even point on the transaction is around $17.3 per share, or about 5.5% downside protection from the stock's price at the time of sale.
Max Profit: Maximum profit is the credit of $3,080.00, less commissions, which will be achieved if the stock is at or above $25 per share at expiration.
Potential Downside: My maximum potential loss on the position is $6920.00, plus commissions, which will occur if the stock goes to $0.
Greeks: Given that these are deep in-the-money puts, the position's delta shows what is roughly a 1 to 1 ratio with the stock's price. Theta is moderately positive because of the roughly $1.00 in extrinsic value and will increase closer to expiration or with a rise in the stock (due to an increase in extrinsic value).
Rationale: Following a recent quarterly earnings miss, True Religion (a high-end jean manufacturer and retailer) has seen its stock price decline substantially to a six-month low, and is now trading at a very compelling multiple of trailing and forward earnings - about 9.6x and 8.6x respectively, less on an enterprise value basis (due to a net cash position of roughly $80M). The company has exhibited tremendous growth during its short existence, has built a great brand (albeit an expensive one) and has a loyal following which has largely continued purchasing the company's products during this long recession. While there is certainly an abundance of competition in the high-end denim market and the continued recession will no doubt dampen TRLG's earnings, I believe the company's current valuation offers a compelling risk-reward ratio over the coming years. To capture a significant amount of this upside, while providing a moderate amount of downside protection, I've sold the July 25 puts. In the event the stock continues to decline and the puts are eventually exercised, I will have purchased the stock at an even more compelling valuation (assuming no serious and permanent decline in the company's business). In the event the stock rises, I will look to exit the position after a significant decline in extrinsic value.
Break-Even Point: Break-Even point on the transaction is around $17.3 per share, or about 5.5% downside protection from the stock's price at the time of sale.
Max Profit: Maximum profit is the credit of $3,080.00, less commissions, which will be achieved if the stock is at or above $25 per share at expiration.
Potential Downside: My maximum potential loss on the position is $6920.00, plus commissions, which will occur if the stock goes to $0.
Greeks: Given that these are deep in-the-money puts, the position's delta shows what is roughly a 1 to 1 ratio with the stock's price. Theta is moderately positive because of the roughly $1.00 in extrinsic value and will increase closer to expiration or with a rise in the stock (due to an increase in extrinsic value).
Rationale: Following a recent quarterly earnings miss, True Religion (a high-end jean manufacturer and retailer) has seen its stock price decline substantially to a six-month low, and is now trading at a very compelling multiple of trailing and forward earnings - about 9.6x and 8.6x respectively, less on an enterprise value basis (due to a net cash position of roughly $80M). The company has exhibited tremendous growth during its short existence, has built a great brand (albeit an expensive one) and has a loyal following which has largely continued purchasing the company's products during this long recession. While there is certainly an abundance of competition in the high-end denim market and the continued recession will no doubt dampen TRLG's earnings, I believe the company's current valuation offers a compelling risk-reward ratio over the coming years. To capture a significant amount of this upside, while providing a moderate amount of downside protection, I've sold the July 25 puts. In the event the stock continues to decline and the puts are eventually exercised, I will have purchased the stock at an even more compelling valuation (assuming no serious and permanent decline in the company's business). In the event the stock rises, I will look to exit the position after a significant decline in extrinsic value.
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