I’ve been sitting on this message from a young Motorola engineer for nine months now. If he’s right, you’ve just saved yourself nine months’ of waiting. Even if he’s wrong, it’s still an interesting message:

I am writing in response to your comment regarding selling a loser stock. I have recently encountered just such a situation. I work in the semiconductor business and I strongly believe in the future of the industry so I try to look for battered semiconductor related stocks. That is not hard to find these days. Two months ago I found what looked to me like the perfect stock, IDTI. They are an excellent company with several semiconductor products. Yet many people consider them to be strictly a memory maker, since they derive a large portion of their revenues from SRAMs. The company was trading in the $15 dollar range, up from $11 a month before but down from highs in the $30 just six months before. Looking at the quarterly reports the company has a book value of ~$9 per share with over $4 per share in CASH. I thought the downside risk was small, while the upside potential for the long term, as well as the short term was huge.

With that in mind I bought 400 shares at $14 3/4. During that time memory prices continued to decline along with the book-to-bill ratio. Thus semiconductor stocks began to fall. I took advantage of that by buying 290 more shares at $13 1/2. Unfortunately, soon after, IDTI warned analysts that they were not going to meet expectations though they still expected to make 15-21 cents per share. The reaction was merciless. The stock plummeted to $10 per share, it has recovered somewhat to $11 today. However I was wondering what I should do. I still believe in the long term prospects of the semiconductor industry, and particularly IDTI. I wasn’t going to sell my shares for $11 today when I thought I got a bargain at ~$15 a month ago. I don’t need the money any time soon so I am content in waiting until it recovers which I believe should happen in a year, maybe two. Yet I really want to take advantage of the incredible bargain that is available today. Unfortunately, I don’t have the cash to buy any more shares today. So I thought that perhaps options could play a role.

My strategy is as follows: Write (sell) a put at a strike price of $10. Collect the premium. In nine months when it expires if the stock is worth more than $10 my options will not get exercised, and I will have profited the premium (without having put any money down). However, if it is worth $10 or less and I get exercised I will purchase the stock at $10. As long as it happens a few months from now I will have the money to invest, but if it gets exercised before then I would have to dip into my savings in order to cover the option. The benefit in getting exercised is that I will have done nine months from now (ideally, if it gets exercised, it will be in nine months) what I wish I could do today: buy IDTI at $10 per share.

The only problem with my strategy is that my broker won’t let me write a put unless I have $10,000 in my account. Since I only have $5,000 in the account, I need to double my money before I can execute my plan. If that happens, then IDTI would have to have gone up, since it is a bulk of my assets, thus it wouldn’t be the bargain that it is today; consequently, I wouldn’t want to pursue the option strategy anymore. Regards, Swastik.

Got all that? Here we are nine months later, and IDTI is 10-1/8, last I checked. (In the intervening months, it dipped to 7 and a fraction and got somewhere north of 11 for awhile.) Had Swastik been allowed to execute his “put” strategy — taking in a couple of hundred dollars in return for agreeing to buy 100 shares of IDTI at $10, should the price drop below 10 — he would most likely have gotten to keep that couple of hundred bucks. At expiration, IDTI was above the $10 strike price of the puts, so the owner of the put would not have wanted to sell IDTI shares to Swastik at 10.

But just because it would have worked out OK, with hindsight, doesn’t mean his strategy was a particularly good one. His income from the puts, had he been able to sell them, would have been completely taxable; so after tax and commission, he might have gotten $120 for taking this risk. But what if at the end of the nine months IDTI had been at 7, as it was mid-term? Then he would have been forced to buy the shares at 10 and immediately suffer a paper loss of $300. (At that point, a day or two before the puts were likely to be exercised, it might have been smarter to buy them back on the open market to establish an immediate tax loss, while buying the actual shares of IDTI separately, at 7, for a hoped-for eventual long-term capital gain.)

I like a stock that’s down from 30 to 10. I know nothing about IDTI beyond what Swastik has told me, but — being underweighted in technology stocks and unable to resist a gamble — I bought a few shares. If it looked good to Swastik at 14 3/4 nine months ago, I’ve saved 30% (sale! all merchandise reduced 30%!) and skipped nine months of misery.

I certainly don’t recommend your doing likewise. No, you should wait another nine months and buy a little at 7. That way, you’ll get a further 30% knocked off the price and skip a further nine months of misery.

 

 

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