Chasing Value: 2010 -- #10 E-Trade 'Naked Put'

Posted Dec 31st 2009 2:00PM by Sheldon Liber
Filed under: Competitive Strategy, Options, Chasing Value™, E*TRADE (ETFC)

For the first time my annual picks will include a stock option. I have written numerous blogs this year about something called "naked puts" -- that is a sell to open put position -- committing me to buy a certain number of shares by a certain date if the closing price is less than the strike price.

In this case I have selected the E*TRADE (ETFC) January 2011, $2.50 puts last traded on December 28, 2009 at $0.97 for a 39% return. If it expires, as I am betting it will, by the third Friday of that month I have no further obligation.

This type of option transaction is not available to most investors. It is marginable, but you pay no interest.

Since you receive the cash on the day of the initial transaction, I will add a 4% dividend yield as if I invested the cash in a broad bond market index fund for the year, prorated at the time of each periodic review. Therefore I actually have the potential to make over a 43% return when you add the dividend on the up front cash, and reinvest it during the year as well.

E-Trade has paid a huge price for starting a bank and then mimicking the industries unfortunate lending practices. The trading platform remains first class and is the envy of many a competitor as are their trading customers. There has been a lot of speculation that ETFC will be acquired and I happen to share this view.

E-TRADE ended the trading day, December 28, 2009 at $1.78. The break even on this trade is $1.53 ($2.50 minus 0.97) plus the interest gain for the year holding period.

For the other nine picks see Chasing Value: 10 Stock Picks for 2010.

Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: I own ETFC options.

Tags: 2010, chasing value, ChasingValue, e-trade, ETFC, feauredt, puts, sheldon liber, SheldonLiber, value investing, value stocks, ValueInvesting, ValueStocks

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Reader Comments (Page 1 of 1)

12-31-2009 @ 9:29PM

RT said...

What happens to your position if ETFC gets bought out at less than $2.50 prior to expiration?

12-31-2009 @ 11:58PM

Sheldon L said...

RT,

Good question. Let's make it real. I actually did the trade last month for $1.15 per share. My break-even therefore is $1.35.

The stock closed today 12/31/09 at $1.76, 41 cents higher, a year in advance, so I feel confident I picked a winner. However, if ETFC was acquired say at $1.60, less than today's price, an investor buying today would be losing 16 cents per share when the acquisition is complete and I would still be ahead 25 cents per share plus whatever I made on the cash I got up front and invested during the year.

If the puts were not acted upon until next January -- they would be "put to me" at the $2.50 price tag, and I have a realized gain. I pay the $2.50 per share, get the $1.60 from the acquirer and only make the 25 cents instead of the $1.15 per share. ($2.50 -$1.60 = $0.90 .... $1.15 - $0.90 = $0.25).

For me to lose the acquirer would have to pay less than $1.35, quite a discount to the market price.