As for complacency the Striking Price column included the following; "Selling puts that are 5% or 10% below the stock price and that expire in three to six months never hurts..." Selling puts was generically a great trade in the 90s then the tech wreck came along and put sellers were crushed. Then there were a few more years of good times followed by the financial crisis which again crushed put sellers. The market is now three years from the low and put selling has generally been a great trade again. While there is no way to know when, I promise you there will be some future event that again crushes put sellers.
For anyone unfamiliar when you buy a put you have the right to sell stock to someone (the put seller but actually early assignment is random) at the strike price of the option. Buying a put is either a hedge or a speculation that the price will decline, the seller of the put does not expect the price to drop below the strike price of the put he sells.
The context of the Barron's quote was selling puts 5-10% out of the money targeting a three-six month expiration. A great example of how this can blow up can be found with Akami (AKAM) from 2000. On March 10 of that year the stock closed at $296. A put 10% out of the money would have had a strike at $260 (if memory serves, up that high strike prices were struck every ten points) and based on the Barron's comment someone may have sold a June or July strike (I don't remember the cycle that AKAM was on back then) or maybe September or October.
By April 10, 2000 the stock was down to $133. By May 10 it was down to $77. The put sold in this example that was $35 out of the money was $183 in the money. This is likely a permanent impairment of capital when it is bought back or if the position is held until expiration resulting in assignment. The seller of the put must buy 100 shares for $26,000 when the market value is only $7,700.
The reason I think AKAM is a good example is because there was no fraud at the company, it did not fail--it actually has a very important function but it got caught up in the hype and then got crushed.
The next time selling puts becomes a bad idea there will be people short a whole bunch of puts from the "wrong sector."
The other point from Barron's (this was repeated in a couple of places) was a repeat of the idea that the Fed's interest rate policy (and the other attempts to stimulate the economy) are forcing investors into other instruments to seek a "reasonable return."
There are a lot of people who have put cash and bond money into dividend stocks because dividend stocks have done well lately and either they or their advisors have become complacent about the risks of owning stocks. We all have some amount of our liquid net worth that should be in cash. For one person it might only be 2% and for someone else maybe it should be 90% but either way too much "safe" money into stocks has a high probability of ending badly. Opportunity lost is far better than actual money lost.
As a note to the dividend crowd at Seeking Alpha, this is not pointed at you, some of whom say they like it when prices drop so they can buy more and so on. If you comment regularly all over that site about dividend stocks and do what you say you do then you are strong hands but the people above would be best thought of as weak hands. All stocks have strong and weak holders and I promise you that the weak holders will sell into the face of something bad--this is normal market behavior and has nothing to do with the merits of a stock or a strategy. I believe client holding Philip Morris Intl (PM) is favorably viewed by the dividend crowd yet it went down 32% from when it spun off in March 2008 into the March 2009 low--weak hands not bad stock.
The picture is at Crater Lake from 2010.
4 comments:
If you want to buy a stock at a given price based on intrinsic value, selling a naked put on at that price pays you for waiting. Similarly selling a covered put as a stop loss is a reasonable strategy which, once again, pays you for waiting. Both are reasonable approaches to offset opportunity cost but they take discipline.
I have some problems with current Fed policy too but mostly because I do not consider it aggressive enough.
Hi RW,
Covered put? I only know that term as a hedge for a short position. Short stock, sell a put. If assigned then the shares bought through assignment pairs off with the short position leaving the investor flat.
How are you using the term?
Ach, must have been distracted or under-caffeinated when I wrote that: I was thinking of the covered put strategy as the reverse of a covered call (which it basically is) and then blended the two together into nonsense.
I actually haven't used options strategies as a hedge for a long time now, just write them to manage the value segment of my portfolio; covered calls at the price I want to sell the underlying, naked puts at the price I want to buy.
Should have said not hedged with options directly since I do use the more liquid inverse ETF's such as SDS (I obviously own options indirectly in that case).
But all that may be in vain as Dogbert presents THE right plan for the long-lived (and I do mean Right [lol]): http://dilbert.com/strips/comic/2008-01-30/
Those who want to shorten the time those pesky retirement funds will be needed by overindulging should include Voodoo Donuts of course; http://voodoodoughnut.com/menu.php -- some might consider the innuendo PG-13 so if you are of delicate constitution and/or prone to vapors and/or short on humor please do avoid ....
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