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Courtesy of Walter, Sabrient Systems and Gradient Analytics
Options, when used effectively, can turn a non-dividend paying stock–often the case with small-caps—into one that pays you to hold onto shares. This strategy, known as the Buy-Write strategy, involves buying half the shares of a stock you’re willing to own, and writing, or selling, calls and puts against those shares. Selling options gives someone else to the right to call your shares away from you if the stock is increases and the call becomes in the money, or put you shares if the stock decreases and the put becomes in the money.
The key is selecting strike prices that you would feel comfortable selling the shares at or owning more of them at. Most often, the investor comes out ahead in this strategy; either by collecting the premium and sitting on the shares if nothing happens—much like a dividend payment, lowering your cost basis if the shares fall and you end up buying them, or selling your stock for a higher price than you paid when your shares are called. The premiums collected are yours to keep.
The following two stocks were hand selected from among Sabrient’s top small-cap stocks. This list is updated daily. Greenbrier Companies (GBX) is a designer, manufacturer, and marketer of rail car equipment and marine barges in North America and Europe. It currently trades for 8.19 times current earnings and 5.98 times future earnings, considerably lower than its industry and sector peers. With projected earnings growth of over 400% in 2012, 21% in 2013, and 11% over the next five years, GBX is quite attractive.
In each of the last four quarters, it has delivered positive earnings surprises. Most recently at its third quarter earnings announcement in June, GBX raised its forward outlook for the year. However, while it indicated that fourth quarter deliveries could be lower due to longer production times, it also noted that it is increasing production of oil tanker cars due to elevated demand and expects to open a second production line in 2013. GBX is slated to announce fourth quarter earnings on October 29.
Over the last three months, GBX has been trading in $13.50-16.50 range with the exception of two breakouts. It opened today (10/1/12) at $16.33, and its chart indicates that it is in a slight downtrend that will likely end in its recent trading range. I recommend watching the MACD histogram and the Wilder’s RSI for a turnaround if you plan to go long without options.
Otherwise, I recommend the following options strategy: buy half the shares you are willing to own (at least 100) and write (sell) the Dec 17.5 call and the Dec 17.5 put. This spread will bring in a premium of $3.25, lowering the cost basis to just over $13, below GBX’s current trading range. If GBX continues its EPS trend and delivers an earnings surprise, it is likely that your shares will be called away at $17.50, another 8% gain. If GBX misses, you will likely get put shares but your cost basis will be below its current trading range, and given its favorable 2013 outlook, the shares will likely bounce back.
The second stock is MIPS Technologies, Inc. (MIPS). It builds processors for digital, home, and mobile applications; this technology can be found in televisions, Blu-ray players, Wi-Fi access points and routers, and mobile communications for example.
On May 12, 2012, MIPS surged from $5.21 to $6.58, and later to $7.20, before later settling in the $6-7 range where it proceeded to trade until the end of September. It surged on rumors that it had enlisted Goldman Sachs to find a buyer. I used the Buy-Write strategy to profit from MIPS’s trading range by selling $7 June calls and $6 June puts, inflated by volatility, against my shares. I continued to roll those options into September after June expired worthless.
However, on August 31, an analyst that had met with management revealed that MIPS indeed wanted a buyer (investor’s interest was held over the summer because of a great licensing deal with a Chinese chip maker). This analyst expected MIPS shares to picked up by an undisclosed buyer for around $10 by January 2013. Shares surged on the news into the $7-8 trading range. I was forced to buy back the call I had sold to prevent my shares from being called away. Nevertheless, I was able to sell a later expiration call with a higher strike and regain my premium.
My recommendation: Buy half the shares of MIPS you are willing to own, and sell the Jan $9 call and the Jan $7 put for a total premium of $1.35. MIPS opened today at $7.36. This strategy would bring the cost basis down to $6.01. If the buyout happens for price over $9, your shares will be called away for a gain of 21%, and the put will expire worthless! If the buyout doesn’t happen by the time Jan options expire, you might consider implementing this strategy again with an expiration 1-3 months out, depending on the options premiums you can collect. But then again, if the deal doesn’t happen by then, investors could be spooked and shares might fall.
Disclosure: I’m long MIPS and have hedged my positions with options. I’m considering entering a position in GBX.
