With the stock currently trading for around $28.50 per share, the March 2013 $29 put option looks appealing. This option can be sold for about $1.22/contract/share or $122 per contract. If the stock is flat until expiration your effective purchase price would be $27.78 per share. If the stock were to rise above $29 per share then the option would expire worthless and you’d achieve a 4.2% return in about 30 days, or roughly 48% annualized.
Because GM is set to announce earnings on Feb. 14 option premiums are higher than normal due to increased implied volatility. This is typically a great time to sell options because of these high premiums. If we look at a lower strike price, $27 for instance, the premium for the March 2013 expiration is $0.42/contract/share. This strike price is more than 5% below the current stock price but still gives you an annualized return of about 17% if the stock stays above $27 per share. Increased implied volatility is a friend of the option seller.
The Men’s Wearhouse, Inc. (NYSE:MW)
Men’s Wearhouse stock has declined by roughly 8% to around $29.50 per share since I wrote about it here, putting it well below my fair value range of $33 – $44 per share. Earnings are set to be announced on March 6, putting the March 2013 expiration soon after the announcement. This will elevate premiums and allow for exceptional returns.
The March 2013 $30 put option can be sold for $1.85/contract/share or $185 per contract. This is slightly above the current stock price and would give you an effective purchase price of $28.15 if the stock stayed below the strike price until expiration. This price is about 15% below the low-end of my fair value range. If the stock price rises above the strike price the option will expire worthless and you will achieve a 6.17% return in about 30 days or 70% annualized.
Looking at the March 2013 $27 option the premium is $0.60/contract/share, giving you about an 8.5% buffer against a stock price decline. If the stock remains above the strike price you would realize a 2.22% return in about 30 days or 25% annualized.
Of all three stocks I would expect Men’s Wearhouse to be most volatile around earnings. However, since this strategy is grounded in having a reasonable fair value estimate being put the shares at $27 each is not a bad thing.
The Bottom Line
Selling put options in order to buy undervalued stocks allows you to not only set the purchase price but also be paid to wait for the market price to reach that purchase price. And in the case where the option expires worthless you can achieve an exceptional return, especially when an earnings announcement is set to occur before expiration.
The article Get Paid to Buy These Stocks at a Discount originally appeared on Fool.com and is written by Timothy Green.
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