Naked put options, covered calls on BP, RIG, DO, GMR, VZ & more
I made many options trades this week. Some were in existing positions to adjust risk – for example rolling out short options positions that were trading in-the-money, and otherwise generally replacing (or closing out) naked put option positions originally sold at low volatilities with new option positions trading at much higher volatilities.
I also took advantage of the ongoing high volatility in the market to establish some new short option positions. Nowhere was high volatility more in evidence than in the oil and gas drilling sector, where investor hysteria over the Gulf oil spill – and that of many market “experts” as well – had clearly reached a fever pitch. I couldn’t resist some put option selling opportunities there (see below).
Finally I also sold some covered call options against an existing long position in a tanker stock that further reduces my already profitable cost basis in the position.
Closed/Adjusted positions:
BP Plc [[BP]] – On 6/9/10 I rolled out and down the remaining half of the January 50-strike put option position I’d sold against BP on 4/27/10 (which was now trading deep in the money and whose premium was almost entirely intrinsic value) by buying it back at a loss and selling an equal number of January 2012 35-strike LEAPS put options (whose hefty premiums were mostly reflecting time value) for a small net loss. As a result I lowered both my cost basis in the position (to $35 if ultimately put the shares) and my overall position size. I also did so at a minimal overall net debit in the naked put option position (amounting to only about 2% of the overall position size).
Cintas Corp. [[CTAS]] – On 6/9/10 I bought to close the August 22.5-strike put options I’d sold against CTAS on 1/15/10 for a 5-month net return of about 0.7%. *
Exelon Corp. [[EXC]] – On 6/7/10 I rolled out and down the October 40-strike put options I sold against EXC on 4/1/10 by buying them back and selling an equal number of January 37.50-strike put options for an overall net credit, reducing my net cost basis if ultimately put the stock to about $36.65.
Verizon [[VZ]] – On 6/8/10 I rolled out and down the July 27-strike put options I sold against VZ on 1/15/10 by buying them back (for a slight profit) and selling an equal number of January 25-strike put options, reducing my net cost basis if ultimately put the stock to under $23.40.
Walgreen Co. [[WAG]] – On 6/7/10 I rolled out and down the October 33-strike put options I sold against WAG on 3/9/10 by buying them back and selling some January 30-strike put options for an overall net credit, thus lowering my risk in the position and reducing my net cost basis (to about $29) if ultimately put the stock.
New positions:
Diamond Offshore [[DO]] – On 6/8/10 I sold some September 40-strike naked put options against DO as it – and the entire oil and gas sector – continued to plunge during hysteria over the ongoing Gulf oil spill:
Diamond Offshore is one of the world’s largest offshore drilling contractors with a fleet of 47 rigs, including 32 semisubmersibles suited for drilling in rough waters and at depths of up to 10,000 feet. Risks to earnings include reduced deepwater drilling activity (overall and of course specifically in the Gulf of Mexico, which may account for about 20% of next-year’s forecasted earnings), operating risk associated with its drilling activities, and exposure to oil and gas prices.
Trading at about $61 and yielding almost 10% (based on an anticipated – although hardly guaranteed – full-year dividend payout of $6), shares of DO are currently in a steep intermediate-term downtrend and extremely oversold. Certainly a bounce from these levels – near significant support at the $55-$60 level – could be expected, but it also seems likely given the downside momentum that the shares could see the $40s at some point, from which a longer-term bottom might be formed. A strong rebound back above $75 or so would suggest a more positive outlook.
From a valuation perspective, current fair value estimates for DO start at around $65 (using the lowest revised forecasted current and next-year’s earnings and cutting earnings growth estimates in half) and go up to over $100, with an average of about $80. In terms of dividends, the company in recent years has regularly paid out sizable special dividends – in addition to its nominal regular annual dividend payment of $0.50 – amounting to yields ranging from about 3% to over 9%, depending on the stock price.
These payouts can of course be expected to fluctuate depending on the company’s earnings during any given year, but are an added incentive for potential stock buyers. If ultimately put the stock, my cost basis will be under $38.50.
General Maritime [[GMR]] – On 6/10/10 I sold some covered call options against my long position in GMR as the stock rallied strongly (after first selling off sharply) on news the company was adding seven tankers to its fleet:
General Maritime is a leading owner/operator of mid-size crude oil tankers operating in the Atlantic Basin and in the Black Sea. While its recent purchase of additional vessels (which includes five new supertankers (VLCCs)) should be positive for earnings over the longer term, the financing required for the deal has resulted in near-term credit rating downgrades for the company.
Technically, shares of GMR are presenting a relatively neutral intermediate-term picture, having gone nowhere for the better part of a year (and under-performing most stocks in the sector). The recent sharp sell-off and subsequent strong rebound on the tanker acquisition news could mark an intermediate-term (or better) bottom. A drop back below the $6.50 level would turn this picture more negative.
Fundamentally it’s difficult to determine a fair value for GMR stock given the current lack of earnings and the company’s impending need to finance increased debt levels. If the shipping industry is in the process of a turnaround – as seems to be suggested by the performance among most other stocks in the sector – then it may be reasonable to think that GMR may have found a bottom at the $6-$7 level. A (reduced) annual dividend of $0.50 provides a nice 6%+ yield at current levels, but comes with no guarantees it will be maintained.
I originally initiated a long position in GMR shares last November when I was put the stock after the 7.5-strike naked put options I’d sold against it expired in the money. Given my neutral outlook for the shares at the time, I turned around and sold some at-the-money covered calls against them, lowering my cost basis in the shares to below $6. These covered calls expired out-of-the-money last month, leaving me still with my long position in the stock. The new covered call position will lower my cost basis to a little over $5 (not including the dividends I’ve received so far).
Transocean LTD. [[RIG]] – On 6/8/10 I sold some August 30-strike put options against RIG as the stock continued to plunge on investor panic over potential fallout from the ongoing oil spill in the Gulf of Mexico:
This is my second naked put option position in RIG – I’m also currently short some November 30-strike put options. Nothing fundamentally has changed since I initiated my original position, so I won’t repeat my original fundamental and valuation analysis of Transocean.
Pricewise the stock has fallen another 10% or so since then, but the technical picture also remains the same. The stock is extremely oversold and could bounce significantly at any time, but does also seem likely to ultimately trade lower at some point. At the same time, this could set the stage for a longer-term bottom being formed. A move above the $65 level would suggest a more positive picture.
My decision to sell some additional puts against RIG (while still remaining within my normal position size limits) was based on several factors: the quality of the company, the unlikely probability that RIG (or BP for that matter) is at risk of going out of business, the clear hysteria and panic on the part of investors in the sector, and the resulting huge options premiums available (for example the options I sold were trading with an implied volatility of 100%). My net cost basis if ultimately put the stock as a result of this naked put option position will be about $28.25.
* As always, the return on sales of cash secured naked put options 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).
