Simply Puts

As the market continued to move higher this past week and as volatility – as measured by the VIX – approached 52-week lows, I bought back some more of my April-expiration naked put options that I’d originally sold last fall. They were now worth close to nothing and it made sense to take profits.

I also initiated two new short options positions (see below) – naked put options on a drugstore chain and covered call options on a tobacco company. Here are the put options I was short that I bought back:

• Cullen/Frost Bankers (CFR: 54.28 0.00%, yld: 3.17%) – I bought to close the April 40-strike put options I sold against CFR on 10/21/09 for a 4-month net return of about 2.9%.*
• Lowe’s Companies (LOW: 24.01 0.00%, yld: 1.48%) – I bought to close the April 17-strike put options I sold against LOW on 10/23/09 for a 4-month net return of about 3.7%.*

New positions
Reynolds American (RAI: 52.63 0.00%, yld: 6.65%) – On 3/5/10 I sold some January 2011 55-strike covered call options against a long position I have in RAI in my IRA as the stock – and the market – rallied back to recent highs:

Reynolds American is the #2 tobacco company in the U.S. behind Altria Group (MO). It sells five of the 10 best selling cigarette brands in the U.S. and is 42% owned by British American Tobacco (BTI).

Technically, the stock is in a strong intermediate-term uptrend but approaching what could be some stiff upside resistance in the $55 to $60 area. While this could suggest some choppy trading going forward, it would probably take a move below the $49-$50 level to change the intermediate-term picture to something more neutral/negative.

Fundamentally RAI appears currently about fairly valued here in the $55 to $60 range and offers a nice dividend yield of over 6.5%. My original entry price in RAI back in 2008 wasn’t great (just a little below these levels) and – after watching the stock drop into the low $30s during the subsequent market panic – I’m happy to now take the opportunity to sell covered calls to either reduce my cost basis in the position (if the options expire out of the money) or to close it out (i.e., have the stock called away) at a profit and await a better opportunity down the road.

Walgreen Co. (WAG: 34.39 0.00%, yld: 1.53%) – On 3/4/10 I sold some October 30-strike put options against WAG as the stock dipped on minor weakness:

Walgreens operates more than 7,000 drugstores across the U.S., Guam and Puerto Rico. Prescription drugs account for more than half of its sales, with the rest from over-the-counter medications and general merchandise. The company recently announced plans to acquire Duane Reade, a New York City-based drugstore chain of 257 stores that is expected to significantly boost its position in the country’s largest retail and drugstore market.

The stock has been weak since late last year, and sold off further most recently after the company reported disappointing January sales. In addition, the recent acquisition is expected to slightly reduce fiscal 2011 earnings. Still, the intermediate-term technical picture remains generally positive, and the stock is near oversold levels. A break below the $32-$33 support would suggest a more neutral/negative picture.

Fundamentally WAG appears attractive here, with current fair value estimates ranging from the low $30s up to over $60. In addition, the company offers good longer-term growth prospects and is a member of Standard & Poor’s Dividend Aristocrats – an index of companies that have increased dividends every year for at least 25 consecutive years. According to DividendInvestor.com, the company has a five-year dividend growth rate of about 20%.

Also, according to the Wall Street Journal, the company is maintaining plans to buy back $2 billion in stock and has targeted a 35% dividend payout ratio – an increase from the current payout ratio of 24%. I’d be quite comfortable owning WAG in the low $30s or below, which would be my cost basis (with a corresponding 1.9% dividend yield) if I ultimately end up being put the stock.

* The return on cash-secured put sales was based on the premium received from the sale of the options (minus commissions) against the unmargined capital set aside to pay for their possible assignment (i.e., my being put the shares of the stock).

This past week I initiated a new short options position by selling put options in a Canadian energy stock (see below). I also recently bought back a number of April- and May-expiration put options that I’d sold last fall whose premiums had since fallen to levels where they were worth next to nothing. It made sense to close out the positions (i.e., take profits) and free up some cash for other potential opportunities.

Generally I prefer to let the put and call options I sell expire worthless and avoid the transaction costs of buying them back early. This is especially true in my regular account (at E*Trade), where the relatively high commission costs can really take a big chunk out of returns from selling option premiums. However all of the put options I recently bought back were in my IRA (at Interactive Brokers), where commission costs are much lower.

Here are my recently closed positions:

• Boeing (BA: 67.79 0.00%, yld: 2.48%) – I bought to close the May 35-strike put options I sold against BA on 10/26/09 for a 4-month net return of about 2.9%.*
• Chubb Corp. (CB: 51.53 0.00%, yld: 2.72%) – I bought to close the April 40-strike put options I sold against CB on 10/23/09 for a 4-month net return of about 1.6%.*
• Expeditors International (EXPD: 36.62 0.00%, yld: 1.04%) – I bought to close the May 22.5-strike put options I sold against EXPD on 10/30/09 for a 4-month net return of about 2.8%.*
• Genuine Parts (GPC: 40.56 0.00%, yld: 3.97%) – I bought to close the May 30-strike put options I sold against GPC on 10/30/09 for a 4-month net return of about 3.8%.*
• Progress Energy (PGN: 38.67 0.00%, yld: 6.41%) – I bought to close the April 30-strike put options I sold against PGN on 10/6/09 for a 4-month net return of about 1.7%.*

New positions
Cenovus Energy (CVE: 25.57 0.00%, yld: 92.88%) – On 2/25/10 I sold some September 20-strike put options against CVE as it – and the market – opened sharply lower over various U.S. and European economic concerns:

Cenovus Energy is a recent spin-off from Canadian energy firm Encana (ECA). CVE controls the company’s northern Alberta oil sands production and refining joint venture with ConocoPhillips, leaving ECA as a natural gas exploration and production company.

Given that the share split occurred only last December, there’s very little trading history for CVE. To try to represent a reasonable approximation of price history, I’ve appended the two months or so of CVE’s actual trading activity to a split-adjusted ECA price history prior to that, resulting in the above price chart.

This shows that the intermediate-term picture is mixed at best. However, CVE appears to be trading well below its long-term linear regression uptrend line (extrapolated from ECA history) and near its lower trend channel, suggesting a possible buying opportunity at a somewhat depressed price. Potential long-term support appears to be in the $19-$22 range.

Fundamentally, the company recently reported fourth-quarter earnings in line with expectations and set a quarterly dividend of $0.20 (Canadian) a share. Valuation wise, the stock appears somewhat undervalued here given the company’s current earnings and expected earnings growth rate (over 20%) over the next five years – but of course a lot will depend on the price of oil. I’d be quite comfortable owning CVE below $20, which would be my cost basis (with a corresponding 4%+ dividend yield) if I’m ultimately put the shares.

* The return on cash-secured put sales was based on the premium received from the sale of the put options (minus commissions) against the unmargined capital set aside to pay for their possible assignment (i.e., my being put the shares of the stock).

This was February options expiration and yet another “payday” of income generated from selling naked put options. As usual, I had a number of short put options expiring, all of which were comfortably out of the money going into expiration.

Here are the results:

• Abbott Laboratories (ABT: 54.80 0.00%, yld: 2.92%) – Some February 39-strike put options I sold against ABT on 8/28/09 in my IRA expired out-of-the-money (OTM) for a 6-month net return of about 2.7%.*
• Pepco Holdings (POM: 16.92 0.00%, yld: 6.38%) – The February 12.5-strike put options I sold against POM on 8/7/09 expired OTM for a 6-month net return of over 6%.*
• Ship Finance International (SFL: 17.99 0.00%, yld: 5.00%) – The February 10-strike put options I sold against SFL on 9/21/09 expired OTM for a 5-month net return of about 6.5%.*
• Southern Co. (SO: 32.31 0.00%, yld: 5.42%) – The February 30-strike put options I sold against SO on 9/17/09 expired OTM for a 5-month net return of about 3.8%.*
• Trustmark Corp. (TRMK: 23.92 0.00%, yld: 3.85%) – The February 15-strike put options I sold against TRMK on 10/21/09 expired OTM for a 4-month net return of over 4%.*

* The return on cash-secured put option sales was based on the premium received from the sale of the options (minus commissions) against the unmargined capital set aside to pay for their possible assignment (i.e., my being put the shares of the stock).

I sold more put options this week as opportunities presented themselves as the market fell sharply and volatility expanded. The sell-off so far appears to be a well-deserved correction – one that’s going about doing its job of scaring market participants quite effectively.

Many individual stocks are at or fast approaching intermediate-term oversold levels, although it wouldn’t be at all surprising to see 1010-1020 on the S&P 500 in the coming days/weeks. And of course an even more extreme move can’t be discounted.

Keeping this in mind, I’m continuing to initiate new short put option positions, but am also maintaining a conservative approach of selling farther-out-of-the-money and later-dated put options.

New positions:
Banco Santander (Brasil) S.A. (BSBR: 12.36 0.00%, yld: 1.16%) – On 2/4/10 I sold some September 10-strike put options in my IRA against BSBR as it sold off sharply on European sovereign debt fears:

Banco Santander (Brasil) is a Brazilian-based subsidiary of Banco Santander that went public just last October. It’s a full-service bank focusing on commercial banking, global wholesale banking and asset management and insurance, and offers a play on the fast-growing Brazilian economy.

Currently trading at $10.77 (with a dividend distribution policy based on 50% of the company’s yearly net income ($0.14 was paid in 12/09)), the shares are clearly in a downtrend and likely at oversold levels. Fundamentally, based on current earnings and expected earnings growth rates, BSBR appears to be undervalued here. I would certainly be comfortable owning the shares at well under $10, which would be my cost basis if they’re ultimately put to me.

CenturyTel (CTL: 34.02 0.00%, yld: 10.36%) – On 2/5/10 I sold some July 30-strike put options against CTL as it fell on market weakness:

CenturyTel (now CenturyLink) is a regional telecom company offering a range of communications services – including voice, broadband and video – in over 33 U.S. states. Trading at almost $34 and yielding over 8%, its shares, while experiencing short-term weakness, remain in an intermediate-term uptrend. A break below the $32-$33 level would suggest a less positive picture.

Fundamentally CTL is probably about fairly valued here ($34), but appears to represent a reasonable yield play. The company is in fact a Dividend Aristocrat, with a record of 36 years of consecutive dividend increases, and appears to have the earnings and cash flow needed to maintain the dividend. My cost basis if ultimately put the stock will be under $29 (with a corresponding dividend yield of 9.7%).

Harsco Corp. (HSC: 30.98 0.00%, yld: 2.60%) – On 2/4/10 I sold some July 25-strike put options in my IRA against HSC as it fell on market weakness:

A diversified mid-cap global infrastructure play, Harsco provides industrial services and engineered products in three segments: Infrastructure, Metals, and Minerals & Rail. Currently trading between $28-$29 and yielding 2.9%, its shares are presenting a somewhat neutral intermediate-term picture, which would worsen on a break below the $25-$27 level.

Fundamentally HSC currently appears roughly fairly valued to somewhat undervalued here with good growth potential tied to the global economy. The company has also earned status as a Dividend Achiever – an index of companies that, among other things, have increased their annual regular dividend payments for the last ten or more consecutive years. If ultimately put the stock, my cost basis will be under $24 with a corresponding dividend yield of almost 3.5%.

Kinder Morgan Management (KMR: 57.76 0.00%, yld: N/A%) – On 2/5/10 I sold some August 50-strike put options in my IRA against KMR as it fell on market weakness:

Kinder Morgan Management oversees the businesses of Kinder Morgan Energy Partners L.P. (KMP), one of the largest pipeline master limited partnerships (MLPs) in North America. KMR itself is not an MLP, but trades in tandem (at a varying discount) with KMP. In addition, it pays a dividend in the form of shares (like a DRIP) that offers an effectively higher yield than that of the MLP that it controls and manages.

Fundamentally, KMP/KMR appear somewhat on the expensive side based on price to distributable cash flow (DCF) compared to some other MLPs, but are trading in line with the sector with an average distribution yield of 7% (7.9% for KMR). Standard & Poor’s currently rates KMP a five-star “strong buy,” based on an expected forward distribution yield close to 6% (a premium to its peers).

Technically the shares of KMR have been performing extremely well until just recently, when the sector (and overall market) suffered a sharp down draft. However the intermediate-term trend remains positive, and it would probably take a break below the $49-$50 level to change this picture to something more negative. Meanwhile I’d be quite comfortable owning KMR at the $47-$48 level, which would be my cost basis (with a corresponding effective yield of 8.8%) if ultimately put the stock.

Sunoco Logistics Partners L.P. (SXL: 68.57 0.00%, yld: 6.14%) – On 2/4/10 I sold some August 60-strike put options against SXL as it fell on both market weakness and a secondary offering by its general partner:

Sunoco Logistics Partners L.P. is a master limited partnership (MLP) formed by Sunoco to acquire, own and operate refined product and crude oil pipelines and terminal facilities in 13 states located in the northeast, midwest and southwest United States. Trading at about $63 and yielding 6.7%, the units of this MLP remain in an intermediate-term uptrend, despite having taken a sharp hit over the last several days. A break below the $59-$60 level would suggest a less positive picture.

Fundamentally SXL appears to offer a better-than-average balance sheet with strong earnings and free cash flow and decent growth prospects. Valuation wise it seems reasonably priced here on a price to distributable cash flow basis, and its yield is in line with other investment-grade MLPs.

Standard & Poor’s currently rates SXL a four-star “buy,” based on an expected forward distribution yield of below 6% (a premium to its peers). My cost basis if ultimately put the units will be below $58 with a corresponding distribution yield of 7.4%.

More market weakness this past week presented me with the opportunity to sell more put options on stocks I’d like to own at lower prices. As it turned out I ended up initiating only three new short put option positions (below), although many more of my limit orders to sell puts came very close to triggering late on Friday.

New positions:
Norfolk Southern (NSC: 53.74 0.00%, yld: 2.53%) – On 1/29/10 I sold some January 2011 40-strike LEAPS put options against NSC in my IRA as the stock fell on market weakness:

This major U.S. railroad company operates in 22 eastern states, the District of Columbia and Ontario, Canada. Much of its revenue comes from transporting coal, so demand and pricing for this fossil fuel can significantly impact profits.

Its shares – currently trading at $47 and yielding 2.9% – barely remain in an intermediate-term uptrend after falling almost 15% in the last couple of weeks and are fast approaching oversold levels. A break below the $45-$46 level would suggest a more neutral/negative picture.

Current fair value estimates for NSC range from about $35 to over $65, with an average calculated fair value of about $45. NSC’s dividend history hasn’t been great – it cut its dividend in 2001 – but the company has consistently raised its dividend over the last six years at a pretty good clip (at a three-year growth rate of 25% according to DividendInvestor.com).

I don’t currently own any transportation stocks (although I am currently short some put options on Boeing), so I wouldn’t mind owning a railroad for some diversification. If I’m ultimately put the stock, my cost basis will be about $37, with a corresponding dividend yield of about 3.7%.

Nustar Energy L.P. (NS: 59.29 0.00%, yld: 7.16%) – On 1/29/10 I sold some September 50-strike put options against NS as it fell on market weakness:

NuStar Energy L.P. is one of the largest asphalt refiners and marketers and independent terminal and petroleum liquids pipeline operators in the United States. The units of this master limited partnership (MLP) remain in an intermediate-term uptrend but – like the market – are experiencing short-term weakness. A break below the $54-$55 level would suggest a more neutral/negative outlook.

Fundamentally NS appears to be roughly fairly valued here, although it – like most MLPs – could be seen to have more room to run based on the spread between the average current MLP distribution yield and that of 10-year Treasury bonds, which has traditionally averaged about 200 basis points (2%). Relative to other investment-grade MLPs, NS has a slightly-above-average current distribution yield of about 7.6%.

I’d be comfortable owning units of this MLP in the $47-$48 price range or below (with a corresponding distribution yield approaching 9%), which would be my cost basis if my short put options are assigned.

Plains All American Pipeline L.P. (PAA: 56.06 0.00%, yld: 6.53%) – On 1/29/10 I sold some September 45-strike put options against PAA as it fell on market weakness:

Another MLP (see Nustar Energy above), Plains All American Pipeline L.P. operates in the U.S. and Canada and is engaged in the transportation, storage, terminalling and marketing of crude oil, refined products and liquefied petroleum gas and other natural gas related petroleum products, as well as the operation of natural gas storage facilities.

Trading at $53 and yielding 6.9%, the units have been in a strong and sustained uptrend since bottoming in late 2008. While a short-term correction – as appears to have begun – is certainly to be expected, it would probably take a move below the $49-$50 level to change the intermediate-term picture to something less positive.

PAA appears to be roughly fairly valued here, and its distribution yield is on par with other investment-grade MLPs. I’d be happy to own some units of PAA below $45 (with a corresponding distribution yield of over 8%) if I’m ultimately assigned the put options I’ve shorted.

This month’s options expiration freed up significant additional cash in my accounts and as a result I’ve been looking for places to deploy some of it. But high prices and low volatility weren’t making it easy to find good returns.

That changed significantly this past week. Concerns over China and the overall global recovery, questions over Bernanke’s reconfirmation, and yet even more unproductive (to say the least) rhetoric from Washington all sent stocks sharply lower and the VIX spiking all the way back up to over 27.

As a result I took the opportunity to initiate a number of new short put option positions (see below). At the same time I’m mindful that there’s plenty of room for the market to fall further if it chooses to do so, so as usual I’m placing conservative bets on quality companies and keeping plenty of “powder dry” for if/when better opportunities present themselves.

Closed position
Freeport McMoran (FCX: 79.76 0.00%, yld: 0.19%) – On 1/20/10 I bought to close some January 2011 25-strike LEAPS put options I had sold against FCX in my IRA on 1/6/09 (as part of a defensive move of rolling out and down some February ‘09 45-strike puts originally sold in September ‘08) as they were trading at a tiny fraction of their original selling price, resulting in a 16-month net return of about 6.8%.

New positions
Ameren (AEE: 25.57 0.00%, yld: 6.02%) – On 1/22/10 I sold some September 22.5-strike put options against AEE as it fell on market weakness:

I’m currently already long some shares (at higher prices) of this electric utility, which operates in Illinois and Missouri. Early last year I reduced my original losing position in this stock at almost no cost using a short put options strategy and now I’m looking to either reduce the cost basis of my remaining position, or average down through the purchase of some more shares at lower prices.

Trading at about $26 and yielding almost 6%, the shares remain in an intermediate-term uptrend. A break below the $24-$26 level would indicate a more neutral to negative outlook.

Fundamentally AEE appears about fairly valued at these levels, with what should be a sustainable dividend. I’d be comfortable owning more in the low $20s, which would be my cost basis on the new shares if I’m ultimately put the stock.

Applied Industrial Technologies (AIT: 24.23 0.00%, yld: 2.48%) – On 1/22/10 I sold some August 20-strike put options in my IRA against AIT as it sold off on market weakness:

Applied Industrial Technologies distributes various industrial parts in North America and provides a variety of engineering and repair services to industrial companies, such as Vulcan Materials. AIT was included as a “deep value” pick in Fortune Magazine’s 2008 Fortune 40: Best stocks to retire on and is listed among the holdings of the Royce Special Equity Fund, a fund that combines small-cap value investing with “accounting cynicism.” (See an interesting WealthTrack interview with Charles Dreifus, the fund’s manager.)

Trading at about $23 and yielding a little over 2.5%, AIT’s shares remain in a clear short- and intermediate-term uptrend, despite reporting lower-than-expected fiscal second-quarter earnings earlier in the week. A break below the $21-$22 level would suggest a more neutral to negative outlook.

Current fair value estimates for AIT range from about $17 to almost $30, so it appears roughly fairly valued here. However a clean balance sheet, a consistent dividend record, and a forecast double-digit earnings growth rate over the next five years make it seem reasonably attractive, especially at a price of under $19, which would be my cost basis if ultimately put the stock.

Banco Santander, S.A. (STD: 14.03 0.00%, yld: 6.19%) – On 1/21/10 I sold some June 12.5-strike put options against STD as it fell on weakness in the sector:

Banco Santander is a large commercial and private global bank headquartered in Spain. It’s a solid bank with decent growth prospects and exposure to emerging markets in Latin America.

Currently trading at about $15 and yielding around 3.7%, its shares are retreating from recent highs at around $18 after having run up there almost in a straight line from their March $5 lows; so a pullback here back down to the $11-$12 area in the coming weeks/months would certainly not be unexpected.

Valuation wise, STD is probably roughly fairly valued at current levels (~$15). I’m comfortable with the idea of owning it at $12 (or lower), which would be my cost basis if it’s put to me, with what should be a corresponding dividend yield – after an 18% Spanish withholding tax – of 4%+.

The Chubb Corp. (CB: 51.53 0.00%, yld: 2.72%) – On 1/21/10 I sold some July 45-strike put options against CB as it fell on market weakness:

Trading at $48 and yielding almost 3%, the shares of this property and casualty insurance provider remain in an intermediate-term uptrend but – like the market – are currently in a shorter-term downtrend. A break below the $45-$46 level would change this picture to something more neutral/negative.

From a valuation perspective, CB appears undervalued here, with current fair value calculations ranging from about $40 to over $100. The Chubb Corporation has a long history (44 years) of dividend increases, earning it the distinction as an S&P 500 Dividend Aristocrat.

I’m already short some April 40 put options that I sold against CB in my IRA last October, but those will be increasingly losing time premium in the coming weeks and seem – at this point anyway – unlikely to end up in the money. The July puts are another story, but I’m very comfortable with the idea of owning CB at the $43-$44 level (and corresponding 3.2% yield), which would be my cost basis if I end up being put the stock.

FPL Group (FPL: 47.02 0.00%, yld: 4.08%) – On 1/22/10 I sold some September 40-strike put options against FPL as it fell on market weakness:

Currently trading at about $48 and yielding almost 4%, the shares of this Florida public utility are in a clear short- and intermediate-term downtrend and appear poised to retest the $45 level at some point. The current weakness can be blamed in large part on the Florida Public Service Commission’s recent decision to deny most of the utility’s rate increase request.

While this is not good news for the stock, which traded as high as the mid $70s two years ago, fundamentally the shares now appear to be roughly fairly valued. Calculated valuation estimates range from the high $30s up to over $70.

FPL has a good dividend history – it has raised its dividend for 14 consecutive years and has a five-year dividend growth rate of almost 8%. While the dividend growth may be called into question in the nearer term, the current payout seems sustainable, and I’d be comfortable owning the shares below $40 (with a corresponding 4.9% yield), which would be my cost basis if I’m ultimately put the stock.

IBM (IBM: 125.55 0.00%, yld: 1.75%) – On 1/20/10 I sold a January 2011 115-strike put option against IBM as it fell on market weakness:

Currently trading at about $125 and yielding 1.75%, the shares of this large computer-services provider are clearly in a strong and extended intermediate-term uptrend but showing short-term weakness, which could certainly develop into a move back to the $110-$115 level. A break below $110 would change this picture to something more neutral/negative.

Valuation wise, IBM appears somewhat undervalued here with current fair value estimates ranging from the low $90s up to over $200. It has a good history of dividend growth – 14 years of consecutive increases with a five-year growth rate of over 20% – and is a Dividend Achiever. I’m comfortable owning the stock below $110, which would be my cost basis if it’s ultimately put to me.

JPMorgan Chase (JPM: 42.42 0.00%, yld: 0.47%) – On 1/21/10 I sold some September 30-strike put options against JPM as it fell on weakness in the sector:

Trading at $39 and yielding 0.5%, the shares of this financial holding company are clearly in a short-term downtrend within a still intact intermediate-term uptrend. A break below the $35-$36 level would suggest a more neutral/negative picture.

Fundamentally, current fair value estimates for JPM range somewhere in the mid- to upper-$30s, which the stock is fast approaching. And it seems likely that the uncertainty from all the bank bashing going on in Washington may create buying opportunities at lower prices among the big bank stocks.

This by itself doesn’t especially interest me, but I was intrigued by the possibility/likelihood that JPM may reinstate a dividend later this year. As a result, I’m comfortable with the idea of owning JPM at under $30 (with a potential yield of around 3%), which would be my cost basis if I’m eventually put the stock.

Kraft (KFT: 29.23 0.00%, yld: 3.97%) – On 1/21/10 I sold some September 25-strike put options against KFT as the shares sold off after the announcement of the Cadbury deal:

Trading at about $28 and yielding over 4%, the shares of this packaged foods products company are in an intermediate-term uptrend but experiencing short-term weakness. A break below the $26-$27 level would change this picture to something less positive.

Fundamentally, KFT appears roughly fairly valued here, with valuation estimates ranging from the low teens up to the high $30s. The Cadbury acquisition would seem to offer Kraft some longer-term positives given the former’s ties in emerging markets, although such mergers are not without implementation risks.

When all is said and done, and barring any significant negative changes in the fundamentals or the dividend, I wouldn’t mind owning KFT in the low $20s or below. If put to me, my cost basis for the shares will be about $24 with a corresponding dividend yield of 4.8%.

NYSE Euronext (NYX: 28.62 0.00%, yld: 4.19%) – On 1/21/10 I sold some January 2011 LEAPS 20-strike put options against NYX as it fell on market weakness:

NYSE Euronext comprises several stock and derivative trading exchanges, including the New York Stock Exchange, Euronext, NYSE Liffe and NYSE Amex (formerly the American Stock Exchange), to make one of the world’s largest exchange groups. Profits are tied to trading volume and various fees for data and other services.

Trading at about $24 and yielding 5%, NYX shares have been underperforming the market since the middle of last year and present a current intermediate-term technical picture that can probably be described as neutral at best. A retest of the $19-$20 support level appears quite possible.

Valuation wise, NYX generally appears somewhat undervalued here, with an average calculated current fair value of around $26. Caveats include minimal/negative free cash flow, pressures from competition and lower trading volumes – not to mention uncertainties over the proposed “crackdown” on proprietary trading at banks – and a potential decision to change the current generous dividend policy.

All in all while I’d be cautious at current levels, I wouldn’t mind owning some NYX at below $19-$20 (which would be my cost basis if put the shares) for what appears to be a good long-term total return potential.

Williams Partners L.P. (WPZ: 40.93 0.00%, yld: 6.21%) – On 1/22/10 I sold some September 30-strike put options against WPZ as it dipped a bit intraday during the broad market sell-off:

Williams Partners L.P. is a master limited partnership involved in gathering, transporting, and processing natural gas and storing natural gas liquids. WPZ’s shares jumped earlier in the week when the company announced it was combining its pipeline and processing units to create one of the largest natural gas partnerships in the U.S. (see company’s press release).

Currently trading at about $38 and yielding 6.7%, the units are clearly in a strong short- and intermediate-term uptrend. It would probably take a sharp break below the low $30s to change this picture to something less positive.

Fundamentally, units of WPZ are now trading at about the same distribution yield as investment-grade MLPs, reflecting the expected upgrade of WPZ’s debt to similar status as well as a first-quarter distribution increase of 3.5%. One of my MLP positions was called away at this month’s options expiration, so I’m looking to add another at some point, and I’d be happy to own WPZ at under $29 (with a corresponding distribution yield of about 9%), which would be my cost basis if the units are ultimately assigned to me.

This turned out to be an eventful options expiration. Not only did I have a lot of short put and call options positions expiring – some dating back to the days of the market panic – but the day’s sell-off also triggered a number of new short put positions.

First, here are the results from the option positions that expired this month:

• American Electric Power Co. (AEP: 34.12 0.00%, yld: 4.81%) – The January 25-strike put options I sold against AEP on 7/7/09 expired out-of-the-money (OTM) for a 6-month net return of about 5%.*
• AFLAC (AFL: 51.25 0.00%, yld: 2.19%) – The January 12.5-strike put options I sold against AFL on 3/10/09 (as part of a defensive move of rolling out and down some August ‘09 25-strike puts sold in January ‘09 that were then deep in the money) expired OTM for a total 12-month net return of around 9%.*
• Arcelor Mittal (MT: 42.21 0.00%, yld: 1.78%) – The January 15-strike put options I sold against MT on 7/8/09 expired OTM for a 6-month net return of about 4.7%.*
• ConocoPhillips (COP: 50.85 0.00%, yld: 3.82%) – The January 30-strike put options I sold against COP on 7/8/09 expired OTM for a 6-month net return of about 4.7%.*
• Emerson Electric (EMR: 47.99 0.00%, yld: 2.77%) – The January 25-strike put options I sold against EMR on 7/7/09 expired OTM for a 6-month net return of about 5.9%.*
• Freeport McMoran (FCX: 79.76 0.00%, yld: 0.19%) – Some January 30-strike LEAPS put options I sold against FCX on 12/17/08 (as part of a defensive move of rolling out and down some February ‘09 35-strike puts originally sold in late September ‘08 that were then deep in the money) expired OTM for a total 16-month net return of around 15%.*
• Ingersoll Rand (IR: 33.84 0.00%, yld: 1.15%) – Some January 15-strike covered calls I sold against my long position in IR on 3/31/09 (as a way to exit the position after the company slashed its dividend) expired in-the-money (ITM) and my shares were called away for a 14-month net return (from the time put options were originally sold on IR to closing of the long stock position) of about 30%.
• International Paper (IP: 25.09 0.00%, yld: 0.40%) – Some January 15-strike covered calls I sold against my long position in IP on 4/24/09 (as a way to exit the position, which had been a real loser in every respect) expired ITM and my shares were called away for a loss in the position of about 60%.
• Harley Davidson (HOG: 26.68 0.00%, yld: 1.50%) – The January 2010 10-strike LEAPS put options I sold against HOG on 1/12/09 expired OTM for a 12-month net return of about 35%.*
• Kimberly Clark (KMB: 60.01 0.00%, yld: 4.10%) – The January 40-strike put options I sold against KMB on 5/27/09 expired OTM for a 7-1/2-month net return of about 2.5%.*
• Kinder Morgan Energy Partners (KMP: 64.35 0.00%, yld: 6.53%) – The January 50-strike LEAPS put options I sold against KMP on 1/22/09 (as part of a defensive move of rolling out and down some March ‘09 52.5-strike puts originally sold in September ‘08 that were then deep in the money) expired OTM for a total 15-month net return of around 13%.*
• Magellan Midstream Holdings, L.P. – The January 25-strike covered calls I sold against my long position in MGG (since bought out by MMP) on 6/5/09 expired ITM, resulting in a 19-month net return of 16.7%, not including the 7-8% annual yield on cost I received in distributions during the time I held this position.
• NYSE Euronext (NYX: 28.62 0.00%, yld: 4.19%) – The January 15-strike put options I sold against NYX on 7/8/09 expired OTM for a 6-month net return of about 4.3%.*
• Procter & Gamble (PG: 63.30 0.00%, yld: 2.78%) – The January 45-strike put options I sold against PG on 8/6/09 expired OTM for a 5-month net return of about 2.7%.*
• TEPPCO Partners L.P. – The January 30-strike put options I sold against TPP (since bought out by EPD) on 6/29/09 expired OTM for a 6-1/2-month net return of about 8%.*
• Verizon (VZ: 29.91 0.00%, yld: 6.25%) – The January 25-strike put options I sold against VZ on 8/17/09 expired OTM for a 5-month net return of about 2.9%.*

New positions
Cintas (CTAS: 26.15 0.00%, yld: 1.84%) – On 1/15/10 I sold some August 22.5-strike put options against CTAS as it dipped on market weakness:

Currently trading at about $25 and yielding 1.8%, the shares of this uniform supplier are currently experiencing short-term weakness – the company recently reported weaker-than-expected second-quarter earnings due to lower sales as a result of job losses in the economy – within a still positive intermediate-term trend. A break below the $24-$25 level would suggest a more neutral or negative intermediate-term picture.

Fundamentally, despite somewhat lowered earnings estimates, CTAS appears to be still reasonably valued here. Given its long history of dividend growth (CTAS is recognized as a “Dividend Achiever“) and still-intact long-term overall growth prospects, I would be very comfortable owning it in the low $20s, which would be my cost basis if ultimately put the stock.

Exelon (EXC: 44.97 0.00%, yld: 4.67%) – On 1/15/10 I sold some July 40-strike put options against EXC as it dipped on market weakness:

Exelon is an electric utility that distributes gas and electricity in Illinois and Pennsylvania, and also sells power to other utilities. It’s the largest operator of nuclear plants in the U.S., which could prove positive in the longer-term if the U.S. ever gets its act together on nuclear energy.

Fundamentally over the intermediate term the company is expected to show flat or slightly declining earnings until regulated price caps on its PECO subsidiary expire next year. Current fair valuation estimates for its stock range from somewhere in the $30s up to the $80s, with an average calculated fair value at just about where it’s trading now (~$49 and yielding 4.3%).

Given EXC’s earnings prospects over the nearer term, I’d be cautious at these levels even though the stock is down almost 50% from its highs. At the same time, EXC should do well longer term and its dividend appears sustainable in the meantime. As a result, I’d be comfortable owning the stock below $40 – with a corresponding 5%+ dividend yield – if it’s ultimately put to me.

Mine Safety Appliances (MSA: 26.06 0.00%, yld: 3.68%) – On 1/15/10 I sold some June 20-strike put options against MSA as it dipped on market weakness:

Mine Safety Appliances makes protective equipment used by workers in the mining, fire service, homeland security, construction, and other industries, as well as the military. Trading at about $26 and yielding 3.7%, its shares remain in an intermediate-term uptrend from their March ‘09 lows, but have been relatively flat since August ‘09. A break below $23-$24 would suggest a more neutral/negative picture.

Valuation wise, current fair value estimates for MSA range from about $15 to over $43, with $28 the average. The company has a long history of consistent dividend growth, and its earnings growth estimates are 10% over the next five years. I’d be comfortable owning the stock below $20 – with a corresponding dividend yield of almost 5% – if it’s ultimately put to me.

Verizon Communications (VZ: 29.91 0.00%, yld: 6.25%) – On 1/15/10 I sold some July 27-strike put options against VZ as it dipped on market weakness:

Trading at around $31 and yielding over 6%, the shares of this telecom services provider have been trading essentially sideways since late 2008. The current intermediate-term technical picture appears somewhat neutral, with an upward bias. A break below about the $28-$29 level would have more negative implications.

Fundamentally, the shares appear to be roughly fairly valued here, with current fair value estimates using a variety of methods ranging from as low as $13 up to $40. I’d be comfortable owning VZ below $27 – with a corresponding dividend yield of over 7% – if it’s ultimately put to me.

Wal-Mart Stores (WMT: 54.06 0.00%, yld: 2.03%) – On 1/14/10 I sold some January 2011 50-strike LEAPS put options against WMT on weakness in my IRA:

WMT is one of the few stocks showing up on my stock valuation spreadsheet as still undervalued (though not by a huge amount) in the current market. Currently trading at about $54 and yielding 2%, the shares of this giant discount retailer are in a clear intermediate-term uptrend. It would probably take a move back below the $50-$51 level to change this positive picture.

From a fundamental perspective, current fair value estimates for WMT range from $45 up to almost $70. I wanted to put some cash to work in my IRA, and by selling the $50 LEAPS put options I’ll either generate a decent 5.5% return on the position (based on the premium received from the sale of the options against the unmargined capital set aside to pay for the possible purchase of the stock if the options are ultimately assigned) or end up buying the stock at an attractive net cost basis of about $47.5 and corresponding 2.3% dividend yield.

* As always, the return on cash-secured put sales was based on the premium received from the sale of the options (minus commissions) against the unmargined capital set aside to pay for their possible assignment (i.e., my being put the shares of the stock).

An article on Barron’s this past week argues that selling puts is likely to emerge as a key options market theme this year.

The article, Monetizing the Fear of Others, notes that – in addition to enabling investors to potentially buy stocks at below market prices – selling puts lets investors “leverage the residual fear” of another market decline as defensive investors continue to buy put options for protection:

Anyone who sells puts effectively takes advantage of the residual concern amongst many major stock investors that stock prices could decline if the sleeping hobgoblins of the economic recovery, including inflation, reassert themselves. This concern is prompting many investors to continually buy puts on stock indexes and individual shares.

This fear among major investors creates opportunities for nimble investors to sell out-of-the-money puts that expire in one to three months on stocks that they would like to own.

Barron’s, 01/04/10

It’s good to see the option strategy of selling puts receiving more attention, however I can’t help but note that increased investor interest in writing puts (and buying calls) is almost certainly a sign that the risks for blindly following such strategies are increasing. In fact, a much better time for selling puts was a year ago, when the market was down substantially and volatility and option premiums were dramatically higher.

Still, selling cash secured puts (where enough cash is available in the account to buy the shares of the underlying stock if the short puts are assigned) remains a great strategy, especially for more conservative income-oriented traders and investors. I prefer it to the much more popular – and technically equivalent – strategy of selling covered calls.

As I point out in this blog’s introduction, selling puts can be a win-win strategy – in effect it lets you get paid to place limit orders to buy stocks you want to own at lower prices. The Barron’s article gives an example of this using Apple (AAPL).

Bottom line: Investors who include put option writing (and other options strategies) in their repertoire of investing tools have added flexibility over traditional equity-only investors in finding ways to reduce risk and enhance return in any market environment.

Some recent option trades include covered calls on a stock I’ve been long – and losing money – in since last April and a couple of new positions in some short cash secured puts. The covered call position is designed to take advantage of the market’s extended run-up, while the short put positions are geared toward generating some additional potential income over the next six to eight months:

The Buckle (BKE: 34.42 0.00%, yld: 7.55%) – On 01/07/10 I sold some June 22.5-strike put options against BKE as it pulled back somewhat after opening higher on better-than-expected same-store sales figures:

Trading at about $32 and yielding 2.5%, the shares of this specialty retailer of casual clothing for 12- to 24-year-olds are currently in a strong short-term uptrend and a neutral-to-positive intermediate-term trend. A break below the $27-$28 level would change this picture to something more negative.

BKE appears to be a reasonable value here based on its growth rate and estimated earnings going forward, with most current fair value calculations ranging from around $20 up to over $60. The company appears to be conservatively run with a good balance sheet and free cash flow, and has even paid out a sizable special dividend the last couple of years. While I’m wary of the company’s reliance on successfully staying in sync with fickle fashion trends, I’d feel comfortable owning the shares in the low $20s, which would be my cost basis if I’m ultimately put the stock.

Olin Corp. (OLN: 18.66 0.00%, yld: 4.29%) – On 01/06/10 I sold some August 15-strike put options against OLN on a dip in the stock price:

Olin Corporation is a manufacturer of both chlor alkali products (which are used to make bleach, water purification and swimming pool chemicals, among other things) and Winchester-brand ammunition. Trading at about $18 and yielding 4.5%, the stock remains in an intermediate-term uptrend from its March ‘09 lows, but has been trading mostly sideways since last August. A break below the $15 level would suggest a more clearly neutral to negative technical outlook.

In terms of valuation, OLN appears about fairly valued here. Earnings estimates for 2010 vary quite a bit, with resulting calculated fair values ranging from somewhere below $10 to over $20. I’d be comfortable initiating a position below $14-$15, which would be my cost basis if I’m ultimately put the stock.

Prologis (PLD: 13.40 0.00%, yld: 4.48%) – On 12/24/09 I sold some January 2011 15-strike covered calls against my long position in this REIT:

Like another REIT that I’ve mentioned recently (Developers Diversified Realty (DDR)), this developer of global industrial distribution properties experienced a near-death experience during the financial crisis as a result of an over leveraged balance sheet. The subsequent forced deleveraging resulted in all-too-familiar share dilution and dividend cuts – and a much lower share price (and yield on cost basis for existing shareholders) going forward.

PLD may be a reasonable longer-term holding for buyers at these or lower levels, but at my cost basis ($26-$27) it represents a clear loser in my portfolio that is ripe for weeding out. However, rather than just sell it outright here, I elected to capture some significant option premium by selling at-the-money LEAPS calls against it to generate some income and provide some downside protection while giving the position some more time to play out (and to pay out some more dividends, reduced as they may be). If my shares of PLD are called, my effective sale price (including the option premium) will be about $18.

This past Friday was December options expiration and I had two options positions expiring – one a short put position and the other a covered call:

• Anglo American plc (AAUKY: 0.00 N/A, yld: N/A%) – The December 12.5-strike covered calls I sold against my long position in AAUKY on 7/10/09 as a way to exit the position at breakeven expired in-the-money and my shares were called away.
• Bank of Montreal (BMO: 57.71 0.00%, yld: 4.39%) – The December 40-strike put options I sold against BMO on 9/24/09 expired out-of-the-money for a 3-month net return of about 2%.*

* As always, the return on cash-secured put sales was based on the premium received from the sale of the options (minus commissions) against the unmargined capital set aside to pay for their possible assignment (i.e., my being put the shares of the stock).