I’m going to let you in on a little secret. My favorite investment strategy is writing puts. This simple strategy has just two possible outcomes, you will either buy your desired stock at a price you are willing to pay or the put will expire leaving you with at least having earned some income for trying. This win-win outcome makes it such an optimal investment strategy for buying a stock that I think it’s a strategy all investors need to learn.
I realize that many investors are wary of options and for good reason. If used incorrectly, you can get burned because options involve leverage, which can be dangerous. However, if used wisely options are a great tool to make your portfolio even better.
To put this simple investment strategy into practice, I’m going to run through three examples of companies I personally am looking to buy. These three companies are all onshore oil and gas producers that are working to turn things around after the gas bubble burst. This is where the cardinal rule of writing puts comes into play, you must be willing to buy the underlying stock at the strike price.
Topping the list of companies I’d like to buy cheaper is SandRidge Energy Inc. (NYSE:SD). The oil and gas producer has come under intense pressure from activist investors who don’t like the way management has led the company. Further, its share price had been pressured by the debt it took on as it shifted from natural gas to oil; it’s focused its attention on becoming the dominant player in the Mississippi Lime. Those past missteps have the company trading at a compelling value – the company currently pegs its net asset value at $32 per share, while those same shares now trade at just over $5 apiece.
I like the turnaround story, but I don’t want to pay a penny more than $5 a share for the company because much risk still remains. I could just place a limit order and hope it hits, but by using put options as my investment strategy I can write the September $5 put options for around $55 per contract. That leads to two potential outcomes. First, the puts could expire and I’d be left with just that income. At more than 10% in just a few months, it’s quite a payout. That being said, if I am assigned shares I’d be able to buy SandRidge Energy Inc. (NYSE:SD) for $4.45 a share which is less than its 52-week low. That’s a win-win proposition if you ask me – earning healthy income or buying a stock below its 52-week low would both be terrific outcomes.
Another company I’m looking at is Chesapeake Energy Corporation (NYSE:CHK). Like SandRidge Energy Inc. (NYSE:SD) it’s been weighed down by debt as the bursting of the gas bubble forced an expensive transition from gas to liquids. However, things are looking up as the company is making very good progress in its turnaround plan. Further, a big cloud of uncertainty was recently removed as it finally announced a successor to its embattled former CEO, Aubrey McClendon. I think that the future looks very promising and Chesapeake Energy Corporation (NYSE:CHK)’s stock is one I am very interested in owning.
Again, I could just buy shares but there is the potential for a bumpy ride so I’m looking at using put options as my investment strategy to buy shares cheaper. In this case, the October $20 puts look appealing. Recently paying around $100 each, by writing these puts I would earn 5%, or potentiality buy shares for $19 each. That’s a nice discount from what I’d have to fork over to purchase shares today, which is why I like writing puts.