by Lawrence Meyers | January 9, 2013 8:44 am
I’m considering a few interesting option trades this year, and they involve selling naked puts on stocks that are expensive on a per-share basis.
The concept is to grab large absolute-dollar premiums, and if the stock doesn’t get put to me, I’ve made a very nice bundle of cash. If they do get put to me, I’m perfectly happy to hold them because I’m getting these shares at a good price, providing ample downside protection should the stock fall.
Here are three good examples:
Priceline (NASDAQ:PCLN) always seemed like a gimmick to me, but this company has soldiered on and become a massive brand name for online travel. Earnings per share are growing at almost 30% in 2012 and are forecast for 24% in 2013. Analysts have a 20% long-term growth target, and backing out Priceline’s enormous cash position, the stock trades at 15.5x this year’s estimates.
This is very attractive to me because it’s both a growth and value play. So, selling an out-of-the-money naked put gives me tremendous downside protection on top of being intrinsically undervalued.
At Tuesday’s close of $657, the January 2014 560 Put is going for $51. That means a $5,100 cash deposit into your account, giving you downside protection to $510 on Priceline — a 23% drop from here. I don’t see travel cratering in the next year as the economy putters along at 1%-2% growth, so this could be worth considering.
Mastercard (NYSE:MA) now trades at $517 and has $45 per share in cash, giving it a net price of $472 as of Tuesday’s close. The company is broadly diversified, has $2.7 billion in free cash flow over the trailing 12 months and has virtually no capital expenditures.
It’s growing at 18% annually, and its strong cash flow and cash position give me reason to value it at 20x earnings. On 2013 earnings of $25.62, that gives it a fair value of $512, so the company is arguably 10% undervalued.
I can sell the January 2014 480 Puts for $35 and still have downside protection to $445. That would have the stock put to me at 15% below the company’s current value, offering nice downside protection in the case of a market correction.
I want to revisit Apple (NASDAQ:AAPL) because the stock price has changed dramatically since I last wrote about it. At Tuesday’s close of $525, and backing out the $125 in cash it holds, the stock effectively trades at $400. That gives it a P/E ratio of about 8 on 20% long-term growth.
The January 2014 460 Puts are going for $42.50. So, in exchange for a $4,250 cash deposit now, I’m protected down to $417.50. That’s still well below intrinsic value, and the company is both a growth and value play.
I think Apple and Priceline are very much worth considering here. I’m somewhat concerned about Apple not zooming back up to its previous highs as it usually does, which may indicate that downward pressure hasn’t yet abated. However, I think it’s an overall healthy thing that the stock is not as much of a momentum play as it was.
As of this writing, Lawrence Meyers didn’t own any securities mentioned here.
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