Gad: Three Stocks Ripe for Selling Puts
There are two benefits to selling a put: generating income and providing the option to buy shares at a lower price. To actually benefit from these two conditions, one condition must be met for put-selling to work: you must -- I repeat must -- be comfortable owning the underlying stock.
Selling a put requires the seller of the put option to agree to take delivery of the underlying stock at the agreed upon exercise price within a specified period. If that exercise price is not reached during the option window, the premium is pocketed. If the exercise price is reached, then the put-seller must buy the stock at the exercise price and keep the put-premium, thereby reducing the actual cost basis in the underlying stock.
A few stocks meet the above the criteria and are on my list of put-selling candidates.
Probably the most attractive is Dell (DELL). The shares now trade for around $10.50, a new 52-week low, and less than 6x forward earnings. Shares are being priced as if the company has no future, but the exact opposite is true. Dell is slowly transforming from a seller of PCs to a provider of enterprise software solutions to businesses and government. On top of that, the company is buying back loads of stock, announced an $0.08 per share quarterly dividend, and has committed to returning 20% to 25% of its free cash flow to shareholders each year. You can sell the Jan. 13 $10 puts for about $0.75 today. If exercised, your effective cost will be $9.25 a share: buying the shares at $10 but keeping the $0.75, (less commissions of course). Owning Dell at $9.25 would be an outright steal for patient investors. A name like Dell should not be trading for 6x earnings -- even a conservative 10x earnings multiple on the same earnings power creates a $17 share based on fiscal 2013 EPS estimates of $1.70. It's a win-win bet: Either keep the premium or get to buy a ridiculously cheap company for even less.Next up is another tech bellwether, Hewlett-Packard (HPQ), now trading at just over $17, or 1x book value. Book value is not a good measure in the industry but that's because margins and return on equity are so high relative to net asset value. You can sell the Jan. 13 $16 puts for $1.25 a contract. If exercised, you own HP shares for a net cost of $14.75 per share against book value of $16 per share. Otherwise, you collect the premium in four months.
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