One of the advantages of following a certain group of stocks is that you start to recognize behavior in them that can create opportunities for you. In this week’s column regarding options, we look at three well-known stocks that all sold off after earnings, and why selling naked puts against them can generate some good income with low risk.
Remember that when you sell a naked put, you are selling the right for someone else to put the stock to you, or sell it to you, at a particular strike price on or before a particular expiration date of the contract.
Because the trader is selling the stock to you, he wins if the price of the stock is below the strike price, because on expiration he will buy the stock at that lower price and instantly sell it to you at that higher price. He’s paid for the right to do that, so that’s where his risk comes in.
Your risk, obviously, is that you have to buy the stock — which in some cases is good, because you’re buying a stock you’d like at a cheaper price. But obviously, sometimes you’re buying into a round of selling, and sometimes you’re buying after the story has fundamentally changed.
With these three blue chips, though, you’re not at much risk.
Naked Puts on Starbucks (SBUX)
Starbucks Corporation (NASDAQ:SBUX) delivered earnings that disappointed some investors a few weeks ago. The stock characteristically sold off, yet SBUX remains a must-hold company in a core portfolio, in my opinion. SBUX fell from about $60.50 to about $57. It closed Wednesday at $56.23.
Because my fair value for SBUX is about $50, but I’d be willing to pay as much as $65 for it because it is a growth stock with 20% annualized growth expected by analysts, I think it is a reasonable buy at its current price.
But why not try and either get it cheaper or make a few bucks on selling naked puts?
The June 10 $56 naked puts are selling for $1.14. That’s a 2% return for a 30-day holding period, or about 24% annualized. That’s a generous premium for this deal. If SBUX is put to you, you get it at an effective price of $55.09.
Naked Puts on Disney (DIS)
Walt Disney Co (NYSE:DIS) faced the same selloff when earnings missed.
Disney remains a core holding for me, regardless of what is happening at ESPN. Disney will figure it out and it has massive profits from its studio. DIS fell 4% after reporting earnings, yet I think its closing price of $102.29 is not an unreasonable price given its future earnings potential.
I actually see two plays here.
The first is to sell the June 10 $102 naked puts for $1.72. That will first net you a 1.7% return for a 30-day holding period, or about 20% annualized. Depending on what happens there, you could turn around and sell another naked put for July.
Alternatively, you could leap right into July and either sell the $105 naked puts for $4.75 (for a 4.7% return), which would put DIS stock to you at an effective price of $100.25, or you could hedge a bit and sell the $100 naked pts for $2.22, and earn 2.2%. You have a sizable buffer between the current price and that strike, which if put to you, gets you in at an effective price of $97.78.
Naked Puts on Apple (AAPL)
Finally, we have Apple Inc. (NASDAQ:AAPL), which really bummed out investors, who they took the stock down significantly.
I think, however, that AAPL has a floor around $90. It closed Wednesday at $92.50.
Likewise, you have several choices here.
The June 17 $92.50 naked puts are selling for $2.55. So you get a very generous 2.8% return on a 37-day holding period. If AAPL stock is put to you, you get it right at $90, which as I said, is likely a floor for the stock in the near-term. If it isn’t put to you, you get that premium.
You can hedge a bit by selling the June 17th $90 naked puts for $1.57 and that would lower your effective buy price to $88.43. That’s an even bigger margin of safety. If you really want to mix both strategies, you could sell the July 15th $90 naked puts for $2.45. Now you get that 2.8% return, and if AAPL stock gets put to you, it happens at what I consider to be the bargain price of $87.55.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com. As of this writing, he was long AAPL, DIS and SBUX.
