by Lawrence Meyers | August 21, 2013 1:59 pm
Priceline.com (PCLN[1]) has proven to be a great play for those seeking large option premiums. This is a great example of how an undervalued stock that may be too expensive to purchase may provide you with equivalent profits by playing options.
Back on Feb. 4, Priceline was trading at $680. It had $74 per share in net cash, giving it an effective price of $606. Earnings were growing at 20% annually and it was selling for 20 times earnings, making PCLN a good value play when the cash was added in. Everything over the next 12 months in the travel world looked stable, and it was (and still is) a cash flow machine.
Still, I didn’t think Priceline stock would rise more than $100 from where it was, and even if it did, I would then be holding a possibly overvalued company. I couldn’t afford to buy 100 shares of it, either. So even if it leapt to $900, I might make $6,600 or so if I purchased 30 shares.
Instead, I chose to sell naked puts.
First, I looked at the January 2014 585 puts, which were going for $43. I like this, since at worst, the stock would be put to me at a total cost of $542, and I’d be getting a great value. However, I chose not to be greedy. Instead, I sold the July 2013 $585 put for $21. That was $2,100 in premium for only five months’ exposure, and I could roll it over if all went well.
Priceline kept rising beyond my expectations, almost hitting $1,000. Had I purchased 30 shares, and sold out, I would have made a nice $9,000 profit and probably remained sidelined as the stock has gone too far, too fast. However, as the stock rose, I took advantage of the fact that the company remained a value play. On March 26, with the stock at $694, I bought back the put for $9.20, thus far giving me a net profit of $1,086. Then I sold the October $595 put for $23, adding $2,300 to my take for a total of $3,386. The stock price hadn’t changed much, but the change in time premiums made this a good deal.
I did it again on May 14. Now Priceline had soared to $791. With my put now out-of-the-money by almost 200 points, I felt safe enough to buy back the put at $6.30, and sell the October $675 for $16.30, creating another net credit of $1,000, for a total of $4,386.
Priceline kept soaring. On June 26, the stock hit $819. I again felt safe enough to push the expiration date out, but keep the strike price. So I bought back the put for $8.60 and sold the January $685 put for another $23.40, adding another net credit of $1,480.
My total profit thus far, with expiration still the same five months out as it was when I sold the original put, is $5,866.
A few important observations are in order. First, note how I repurchased the put each time. I simply did not feel comfortable exposing myself to having the stock put to me at multiple prices. In addition, holding a sold naked put creates a liability in my margin account that decreases my purchasing power. I didn’t want any more restrictions than I already had.
Priceline has fallen back from its high of almost $1,000 to $930. It has $86 per share in net cash, giving it an effective stock price of $866. The company has EPS growth of 30% slated for this year and next and five-year growth is pegged at 20%. So if I gave it a 25x multiple on $40 per share in earnings, it’s fairly valued at $1,000, and thus selling at an effective discount of 14%.
I looked at buying back the latest put and selling another at a higher strike given the valuation, but the premiums were not as compelling. I saw significant risk that Priceline might give back some of the enormous ground it had covered in the past few months. It’s already backed off almost 70 bucks from its high. I prefer being able to sleep at night knowing that if the stock actually got put to me at $685 (or $600 when you account for the cash it holds), I have plenty of margin for error in regards to further growth.
I also have $5,866 — or another 58 points — of downside protection from the puts I sold. The key to this entire strategy was never to get greedy.
As of this writing, Lawrence Meyers[2] held a Jan 685 naked put against PCLN. He is president of PDL Broker, Inc.[3], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[4] and blogs about public policy, journalistic integrity, popular culture, and world affairs[5]. Contact him at pdlcapital66@gmail.com[6] and follow his tweets @ichabodscranium.
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