Recent Option Transaction

Nike (NKE) Dec 16 $50 Strike Put Option

As part of running this blog that chronicles my journey to financial independence I like to be open and honest with all of my transactions.  Typically that revolves around buying shares of high quality companies that I deem to be at fair value or less.  And occasionally there's a sale of a company like when I closed one of my positions earlier this month.  Being open about the moves I make allows for better discussion with all of you and helps spread ideas around.  If it creates my own "investment journal" to detail why I made the move and my expectations, well that's even better.  

Over the last month or so I've closed and trimmed some positions and now I'm sitting on just over $7k in my FI Portfolio.  Ideally there'd be plenty of choices in the market to get that capital working once again; however, there really isn't much that's trading at fair value, let alone below it, unless you move down on the quality scale.  Due to that I've been trying to target some possibilities to get exposure to some wonderful companies via the options market.

I nearly got a put option on for Altria about a week ago, but after the FOMC chose not to raise rates the premium disappeared.  Mr. Market served up a pretty good opportunity yesterday after Nike, Inc. (NKE) reported disappointing Q1 earnings.  Let's see what the big fuss was about.

Revenues +8%, +10 ex-FX
EPS of $0.73 beat analyst estimate of $0.56 and were +9% year over year
Orders were +5%
Shares outstanding down 3% year over year

So with that kind of quarter from Nike I was a bit surprised to see shares selling off throughout the day.  

In August my fair value of Nike ranged between $53 and $62 and the decline in shares brought it just around the low end of my fair value range.  Shares still aren't a steal, but considering that Nike is actually growing the right way by selling more goods it's worth a look for an outright purchase.

Since big share price declines juice up the option premium I checked out Nike's to see what kind of scenarios were being offered up.  

What'd I Do?

I seriously considered a buy/write call where you simultaneously buy the shares and write a call option on those shares, but in the end decided to stick with the old trusty put option.

Let's go over the pertinent details and then move on to the various ways this can play out.

Company: Nike, Inc. (NKE)
Date Opened: 9/28/2016
Expiration Date: 12/16/2016
Strike Price: $50.00
Price of Contract: $0.95
Premium Received less Commission/Fees: $87.00
Share Price at Time Contract Sold: ~$53.30

How can this play out?

For those that don't know much about options I'll cover the general gist of a put option.  Essentially I'm selling someone the right to sell me 100 shares of a company at an agreed upon price, the strike price, on or before the contract expiration date.  However, I'm not going to just do that for free so I receive the option premium up front.  Think of the option premium as a insurance premium payment.

If the share price rallies back above the strike price then the put option would be out of the money and therefore unexecutable.  So I would just keep the premium and go on the look for other places to invest my capital.  On the $5,000 in cash that the contract represents that's a solid 1.74% return.  On an annualized basis that works out to a 8.04% return.  

Of course the share price could keep declining and if it drops below $50 then I would likely have to purchase the shares for $50 per share.  That would suck; however, the option premium actually gives me downside protection to $49.31.  If I have to purchase the shares my effective purchase price would be $49.31.  So I'd get to purchase the shares at a 7.8% discount to the share price when I sold the contract or at a 7.3-20.8% discount to my fair value range.

In my book that's a win win.

There's one other scenario that can play out and that's if Nike's share price makes a big move higher prior to the expiration date.  In that case I would likely buy back my put option to close out the position and lock in the remaining premium.

In graphical form this is how the put option looks.

Nike (NKE) December 16, 2016 $50 Strike Put Option Profit/Loss Graph

As you can see from the graph my profit is capped at the premium I received.  My loss though is technically capped at a complete loss of the $5k in the situation of Nike going bankrupt between now and expiration.  I'd call that essentially a non-issue.  

The big risk that I'm taking is that the markets, and Nike's share price, completely tanks while the put option is open.  If Nike's share price moves below my break-even price of $49.13 then I would have been better off waiting and just purchasing the shares on the open market.  That's a risk that I'm willing to take though since my fair value for Nike is in the mid to upper $50's.

I've updated my Option Summary page to reflect this change.

Do you incorporate an option strategy with your portfolio by selling covered calls or writing puts?

Please share your thoughts below!

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