Options trades: Naked puts on BX, MON, MRK, BMY & more!
I’ve been on a bit of a put option selling spree recently. Even as the market as a whole has continued relentlessly higher (and become increasingly overvalued by several measures), market sector rotation has presented some opportunities to sell naked put options on some stocks trading at or near reasonably tempting valuations in currently out-of-favor industries.
I initiated new naked put option positions in some healthcare and agriculture stocks, and even a financial – the latter when a limit order triggered on news of the Goldman Sachs charges. I also closed out a longstanding short LEAPS put option position that I initiated a year ago near the lows of the market panic as part of a defensive move involving a losing stock position.
Closed position:
Jabil Circuit [[JBL]] – I bought to close some January 2011 5-strike LEAPS put options I’d sold against JBL on 2/25/09 (as part of a defensive move of selling my then deep underwater long position in JBL at a loss and replacing it with some short LEAPS put options such that I either eventually recovered the loss through depreciation of the option premium or initiated a new position in the stock at a much more favorable price essentially for free). This trade resulted in a 14-month net return of 39% on the short LEAPS put options, recovering almost all of the loss taken on the stock sale.*
New positions:
Archer Daniels Midland [[ADM]] – On 4/6/10 I sold some January 2012 25-strike LEAPS put options against ADM in my IRA on continued weakness in the stock:
Once billing itself as the “Supermarket to the world,” Archer Daniels Midland processes grains – including corn, oilseeds, wheat and cocoa – into products for food, animal feed, chemical and energy uses. The company also operates one of the world’s largest crop origination and transportation networks. Profits are tied to global demand for food and ethanol, with the latter currently being weak due to the recent recession.
Trading at $28-1/2 and yielding 2.1%, the shares are presenting a neutral to negative intermediate-term picture. At the same time, the stock is approaching intermediate-term oversold levels, which could suggest a potential bottom forming in the coming weeks/months.
Fundamentally, ADM appears undervalued here, with current fair value estimates ranging from the mid $20s up to over $40 and above. In addition, the company is a Dividend Aristocrat, and has raised its dividend for 35 consecutive years. Its five-year dividend growth rate is almost 13%.
Normally I don’t like to sell options so far out in time. But ADM’s 2012 LEAPS put options were the most “expensive” (i.e, were trading at the highest implied volatility) and allowed me to add a nice cash deposit to my account – earning a potential 12.4% return on the position if held to maturity – while at the same time allowing me to potentially participate to some degree in the stock if it goes up or even sideways from here in the coming months. If ultimately put the stock, my cost basis will be just under $22.
Baxter International [[BAX]] – On 4/23/10 I sold some January 2011 45-strike LEAPS put options against BAX as the stock continued to sell off sharply following the company’s recently lowered 2010 guidance:
Baxter International makes a variety of medical products – including drugs and vaccines, IV supplies, and dialysis equipment – across three business divisions: BioScience, Medication Delivery, and Renal. Despite near-term earnings disappointments, the company should continue to benefit from its diverse product mix and expected future demand from growth worldwide and an aging population. Competition and regulatory risks are among potential negatives.
Trading at about $49 and yielding 2.4%, the shares have clearly taken a hit recently and – while they may be due for an oversold bounce – are currently presenting a negative (or at best neutral) intermediate-term picture. It doesn’t seem unreasonable to expect that the stock could work its way down to the low $40s in the coming weeks/months.
At the same time, valuation analysis suggests that – despite the lowered guidance – the stock is very reasonably valued here, with current fair value estimates ranging from the low $40s to over $100, averaging around $60. In terms of dividends, the company has a spotty record, but in 2007 changed its dividend schedule from a one-time annual payment to four quarterly payments, and has been increasing the dividend at a healthy double-digit annual rate – and appears to have the earnings and cash flow to continue to do so.
I would be quite comfortable owning BAX in the mid $40s or lower (which would be my cost basis if I’m ultimately put the stock) for its long-term total return potential.
The Blackstone Group L.P. [[BX]] – On 4/16/10 I sold some January 2011 12.5-strike LEAPS put options against BX as the units sold off intraday – along with the rest of the financial sector – as news of the Goldman Sachs lawsuit hit the wires:
The Blackstone Group is a large publicly-traded private-equity firm that provides alternative asset management (e.g., private equity, real estate, hedge funds, credit-oriented funds, CLOs and closed-end mutual funds) and financial advisory services (e.g., M&A and restructuring advice) worldwide. Much will depend on how well the company continues to manage its assets – especially investments made near market highs prior to the economic crisis – but the company’s global exposure and diverse investments, as well as a recovering economy, would seem to be positive factors going forward. (See highlights of the company’s recent first-quarter conference call.)
Currently trading at about $15 and yielding 8%, the units are presenting a somewhat neutral to positive intermediate-term picture. A break below $14 would suggest a more negative/neutral outlook.
Valuation-wise, BX currently appears reasonably valued based on its estimated 2010 earnings and earnings growth going forward, with fair value estimates increasing to $17-$20+ if those expectations are met or exceeded. From a dividend/distribution perspective, the company just announced a change from four equal $0.30 quarterly payments to payments of $0.10 each for three quarters with a larger year-end amount dependent on profits on investments it exits during the year – a not unreasonable approach.
I would be quite comfortable owning BX at under $12 (presumably with a corresponding high single-digit distribution yield), which would be my cost basis if ultimately put the units. (Note: Blackstone is a limited partnership, and as such all investors in the L.P. receive K-1 forms for tax reporting.)
Bristol-Myers Squibb [[BMY]] – On 4/15/10 I sold some January 2011 22.5-strike LEAPS put options against BMY on weakness in the stock:
Bristol-Myers Squibb makes prescription pharmaceuticals in several therapeutic areas, including cancer, HIV/AIDS, cardiovascular disease, diabetes, hepatitis, rheumatoid arthritis and psychiatric disorders. The company is expanding its product portfolio to spur growth (and to offset upcoming patent expirations), cutting costs, and – like most drug makers – is expected to benefit from the recent health reform legislation. Risks include generic competition and potential new product disappointments.
Trading at about $24-1/2 and yielding over 5%, the shares remain in an intermediate-term uptrend but are showing negative divergences on the price oscillators and weakening price action. A move below the $23-1/2 to $24 level would suggest a more negative outlook.
Fundamentally, the shares appear roughly fairly valued here. Earnings growth estimates for BMY seem to range all over the map, resulting in fair value calculations ranging from somewhere in the high teens up to the high $20s.
As for dividends, while BMY doesn’t have a history of raising its dividend every year it has consistently paid a dividend over the years and grown it over time. If ultimately put the stock, my cost basis will be about $21 with a corresponding dividend yield of over 6%.
Merck & Co. [[MRK]] – On 4/14/10 I sold some January 2011 35-strike LEAPS put options against MRK on continued weakness in the stock:
One of the world’s largest pharmaceutical companies, Merck discovers, develops, manufactures, and markets medicines, vaccines, biologic therapies, and consumer and animal products. Cost synergies and an improved product pipeline through a recently completed merger with rival drug giant Schering-Plough might be expected to lead to improving profits going forward, while implementation issues and generic competition are risks.
Its shares, currently trading at about $35-1/2 and yielding 4.3%, are presenting a neutral intermediate-term picture. Recent weakness has created intermediate-term oversold conditions, which could be a sign of a potential bottom in the coming weeks. A break below the $33 level would make this picture more negative.
Valuation analysis is made somewhat uncertain with the company’s acquisition of Schering-Plough, but MRK appears fairly valued to somewhat undervalued here with current fair value estimates averaging in the high $30s. Like Bristol-Myers, MRK has a long history of paying a dividend, but not one of consistent dividend growth (it hasn’t been raised in years) – but the dividend appears safe.
My cost basis if ultimately put the stock will be about $31.70, with a corresponding dividend yield of about 4.8%.
Monsanto Company [[MON]] – On 4/14/10 I sold some January 2012 55-strike LEAPS put options against MON in my IRA on continued weakness in the stock:
Monsanto is a global provider of agricultural products that improve farm productivity and food quality, mainly by applying biotechnology and genomics to seeds and herbicides (such as its flagship Roundup products). After starting off on a very fast growth path a decade ago as a spin-off of the agricultural division of Pharmacia (now part of Pfizer), the company is now facing head winds from increased competition, reduced earnings expectations and a civil antitrust lawsuit by rival DuPont. Positives include the company’s leadership position in a growing industry and its recent acknowledgement of – and backing off from – overambitious five-year goals.
Currently trading at about $65-$66 and yielding 1.6%, its shares are in a clear intermediate-term downtrend. At the same time, they’re also at intermediate-term oversold levels and approaching price support in the $60-$65 area, which could suggest a bottoming process in the coming weeks/months – although given the price action it does seem likely that the stock could trade down into the $50s at some point.
Fundamentally, fair value estimates range from the high $40s to as high as $90, suggesting the stock may be roughly currently fairly valued somewhere around the $60-$70 range. In terms of dividends, the company has raised its dividend for eight consecutive years, with a five-year growth rate of almost 30%.
I decided to sell far-out 2012 LEAPS puts against MON since it allowed me to add a nice cash deposit to my account – earning a potential 10%+ return on the position if held to maturity – while waiting to see if the stock drops to a price level where I’d be comfortable owning it (which will be about a $50 cost basis if I’m ultimately put the stock). In the meantime, while I’ll also participate to some degree if the stock rallies significantly or even just goes sideways for a protracted period, this is mainly a “set it and forget it” position for now.
* As always, the return on sales of “cash secured” 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).
I like the MON trade. I sold shorter expiration naked puts and covered calls on MON for a while, but stopped when my August 2009 covered calls were assigned.
I’d like to get back in on it, but want to wait to see it find support first. There’s so much litigation tied around MON that I’m nervous about how much further it’ll fall. The LEAP is probably safer than I would’ve played it, but then again I’m not trading it again yet.
Thanks for your comment. Yeah, this is one of those cases where a stock I’ve had on my watchlist for what seems like forever (years) finally drops to within striking distance (no pun intended!) of a price I’m willing to pay for it (around $50). So rather than wait any longer, I decided to sell the long-term LEAPS and then sit back and see what happens.
As you point out, there are plenty of reasons why MON could continue lower in the meantime. While it is oversold here – which might indicate a good long-term entry point – an oversold condition is a sign of weakness after all and could well be signaling further weakness to come. And I agree, if I were looking for an opportunity to sell nearer-term and/or closer-to-the-money puts I’d also be waiting for a better opportunity.