Shorted Two Puts Positions — TEVA and CTSH
By Paul Price of Market Shadows (originally published on May 7)
Selling out-of-the-money, longer-term puts can help you board a train after it's left the station. Between the gap down to the strike price plus the option premium received, your ‘if exercised’ break-even price can often be as good as if you had bought the underlying stock much earlier.
The move towards drug company mergers for ‘tax efficiency’ has people looking for the next buyout candidate. TEVA could well be next on some acquisitor's list. We bought 100 shares of TEVA Pharmaceuticals (TEVA) for just $39.96 per share back on Jan. 6, 2014, in our Market Shadows Virtual Value Portfolio .
At that time we also sold one contract each of TEVA Jan. 2016 $42.50 and $45 puts @ $6.05 and $9.50 per share premiums respectively in our Virtual Put Writing Portfolio. The stock did very well for us, even before merger-mania set in.
TEVA was trading about $10 higher, at $49.64, early today. Of course, we wished we’d done more with it four months ago.
We somewhat made up for that error today by selling two new contracts of the Jan. 2016, $45 puts @ $4.80 per share. We must now be ready to buy another 200 shares at a net basis of $40.20 per share ($45.00 strike price – $4.80 put premium). If I could buy more shares at $40.20 right now, I would be thrilled to do so.
Our maximum profit on these new options would be keeping 100% of the $960 received. The stock does not even need to move up for that to happen.
Today's other new option sale was also on an old name for us. IT service provider Cognizant Technology (CTSH) had gone up enough that our short sale of Jan. 2014, puts had already expired for a $750 gain.
CTSH recently hit a split-adjusted high of $54 but had fallen back to $46.62 this afternoon despite posting another great quarterly report. Management says they will earn $2.63 in adjusted EPS during 2014. That would compare quite favorably to the $2.01 figure from 2013.
We sold three contracts of the Jan. $40 puts for $3.92 per share. Our commitment is to be ready to purchase 300 shares at a net cost of $36.08 per share ($40 strike price – $3.92 put premium).
That break-even price is more than $10 below the already reduced quote and would represent a P/E of just 13.7x this year’s projected earnings.
Cognizant has not been available at that low a price in more than seven months. Our best-case scenario would be to keep 100% of the $1,176 premium received. As with our new TEVA position, the shares are already trading far above the strike price selected.
In both cases we will pocket the maximum profits if the underlying shares go up, remain unchanged or even if they drop back by a reasonable amount.
That’s what I call putting the odds in our favor.
