Pete K: ‘What are your thoughts on selling long-term PUT options on companies that you feel will be fine in a couple of years? For example, Cisco’s January, 2003, 20 puts are priced at $6. I could sell one of these puts and have the $600 premium in my account for nearly two years earning interest. Total exposure on the trade would be $1400 or so if CSCO goes to zero in Jan 03. [The $2,000 he would have to pay when the stock were put to him at 20, less the $600 premium he was paid to take that risk.] I wouldn’t mind owning the stock for a long-term hold if it falls below $20 and is put to me. This would be a small part of my portfolio and I think it is a prudent play given that some stocks are being hammered right now and stand a good chance at recovery in two years’ time.’
☞ A put (just to bring everyone up to speed), entitles someone to sell 100 shares of stock at a fixed price – $20 a share in this example. You buy one if you think a stock is going down. You sell one if you think it’s going up . . . or if, even if it does go down for a while, you actually wouldn’t mind owning it.
If you sell one put, you’d better be ready to pay $2,000 for 100 shares of Cisco, in this example, because that’s what you’ve agreed to do. If you sell 30 Cisco puts with a strike price of 20, don’t be surprised if you wind up paying $60,000 for 3,000 shares of the stock sometime before the put expires.
Of course, if Cisco is 21, let alone 41 or 81, the put-holder will not exercise – why should he sell you Cisco at 20 that he could sell in the open market for 21 or 41 or 81? And in that case, the put premium is all yours to keep.
Puts are generally not a good idea, whether buying or selling. If you win, the taxman takes a big slice. Whether you win or lose, there is a brokerage commission to pay (or two, if you decide to unwind your position before the put expires). And if you lose . . . well, you lose.
Pete: You should only do this on the assumption that you will indeed have the stock put to you. Buying Cisco at $20 a couple of years from now would not be fun if it were selling for, say, $5 a share on the open market, even though you had been paid $600 along the way. Even at today’s terribly low price, CSCO is still valued at $143 billion, nearly double the valuation of Ford and General Motors combined. At $5, it would still be valued more highly than General Motors is today. A mere trifle, but still not nothing.