Recent Option Transaction

Altria (MO) Dec 16 $57.50 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.  

There's not a whole lot to like in the market right now if you have a value mindset.  About the only companies that are attractive are companies that are higher up on the growth scale although there's risk there because if the growth doesn't pan out then the value drops significantly.

Over the last month or so I've closed and trimmed some positions which has boosted up my cash position.  My general thoughts on the market are that things are overvalued, companies are having a hard time generating meaningful growth and the best case scenario is that the markets just kind of sit here while the earnings catch up to bring the valuations in check.  There just isn't a fundamental reason that I see for the markets to head much higher.  As such, I don't want to just sit idly by and hope that we get better values so I've been searching the options market.

In September I sold a put option on Nike that I feel gave me a best of both worlds scenario.  I could generate an annual "dividend" yield of over 8% or purchase shares at a 8% discount to the share price.

Well I wasn't quite done yet and sold another put option on Tuesday on dividend growth favorite, Altria (MO).  In September I took a look at Altria (analysis here) and determined I'd be happy to start acquiring shares around $57.50.  Unfortunately, that doesn't mean the markets are willing to oblige as the share price at the time was around $62-64.  So I headed to the option chain to see what kind of possibilities there were.

What'd I Do?

On Tuesday I sold to open 1 put contract on Altria.

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

Company: Altria (MO)
Date Opened: 10/4/2016
Expiration Date: 12/16/2016
Strike Price: $57.50
Price of Contract: $0.59
Premium Received less Commission/Fees: $51.00
Share Price at Time Contract Sold: ~$62.30

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 an 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 $5,750 in cash that the contract represents that's a solid 0.89% return.  On an annualized basis that works out to a 4.43% return.  

Of course the share price could keep declining and if it drops below $57.50 then I would likely have to purchase the shares for $57.50 per share.  That would suck; however, the option premium actually gives me further downside protection.  If I have to purchase the shares my effective purchase price would be $56.99.  So I'd get to purchase the shares at a 8.4% discount to the share price when I sold the contract or at a 0.8-5.0% discount to my fair value range of $57.50-$60.00.

In my book that's a win win.

There's one other scenario that can play out and that's if Altria'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.

Altria (MO) December 16, 2016 $57.50 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 $5,750k in the situation of Altria 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 Altria's share price, completely tanks while the put option is open.  Sadly, that already started shortly after the trade was put on.  Around noon central time on Tuesday there were various concerns of interest rate increases and the ECB ending it's easy money policy which hurt lots of the higher yielding securities Altria included.

So I lost out on lots of potential option premium by selling around noon instead of later in the day.  In fact the current bid/ask around one on Wednesday afternoon is at $0.76/0.77.  That wouldn't move the needle much on my effective purchase price if the option is executed but I missed out on lots of premium yield.  At those prices the premium return if the option expires worthless would be 1.18% or 5.91% on an annual basis.  Oh well, that's what happens sometimes.

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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