The stock market's impressive performance over the last few months has created the typical quandary for investors: choose between chasing stocks at ever-higher levels to face a steep downdraft like the one delivered on Wednesday, or wait for a dip and risk missing another leg up.
I suppose a third alternative is to get (or remain) bearish and establish short positions, but the recent risk and pain involved in maintaining such a stance in the face of this market need not be rehashed.
One course of action that might bridge the gap between trying to buy stocks at reasonable value and waiting for a price dip is selling puts. As we know, selling puts short creates a moderately bullish position in which the maximum profit, no matter how high the price of the underlying shares rise, is limited to the sale price of the put. And if the underlying price falls below the put's strike price, it also reduces the effective purchase price if the short put is assigned.
Finding a Floor
The announcement from
that it's boosting its annual dividend to $1 from the previously negligible level of 5 cents led me to consider how paying a decent dividend essentially puts a floor under a stock's price. While this is certainly not a new concept, I thought including a few other basic criteria would enhance this value approach and help identify attractive candidates for a put-selling program.
My simple screen parameters included stocks trading with a price-to-earnings ratio below 15 times current earnings and below their three-year EPS growth rate; paying a current dividend with a yield in excess of 2%; an absolute stock price above $25; and, of course, they had to be optionable securities.
Unlike buying the shares outright, selling puts doesn't entitle you to collect a dividend. The trade-off is that the premium yield realized through the options price decline, whether from time, a price movement, or a combination of the two, should be equal to or greater than the underlying's dividend yield.
Although Lennar was the catalyst for my research, it didn't make the screen because it's trading at just 7.85 times 2003 earnings estimates and has racked up an annualized EPS growth rate of 28% over the past three years. Despite the increase in its dividend, the yield is still just 1.35% -- well below the 2% threshold. Still, with Lennar currently trading at $76.50, one can sell the November 75 put for $3.50, giving an annualized return of 36% even if the stock stays at current levels.
My screen returned about 90 names, and it should come as no surprise that energy, utility, real estate and financial firms, such as banks and insurance companies, accounted for the majority of the list.
One name that caught my attention and can provide a good example is
Bank of America
. Currently trading at $78.40, the P/E ratio is just 11.2 times its fiscal 2003 estimates, a discount to its 18% average annual EPS growth rate over the past three years. The current dividend of $3.20 provides a yield of 4.05%.
Right now, you can sell the November put for $1.25 providing an annualized yield of 13.4%. Or if the shares decline below $75 and the puts are assigned, your effective purchase will be $73.75, bringing the annual dividend yield up to 4.4%. This seems pretty attractive for a stock that has also gained some 23% in the past 52 weeks.
Here are some other attractive candidates.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to