Earlier today I highlighted the relative weakness from last year’s all time highs in the S&P 500 (SPX) of some prior market leaders that I have dubbed U.S. Consumer Teflong™ Portfolio (read here). The group consists of stocks whose companies produce goods that seem somewhat recession proof Apple (AAPL), Disney (DIS), Nike (NKE) and Starbucks (SBUX). Investors have hit the pause button on this group, despite the SPX only down about 2.5% from its all time highs, with this group down between 10 & 30% from their 52 week and all time highs.
I highlighted a popular strategy of selling out of the money puts in stocks that investors might want to own at a certain level below the market a specific point in time. The worst case scenario is that the stock is at or below the short strike level and you are put 100 shares of stock per option contract sold. If the stock is above that short strike then the put seller receives the premium. Here were the examples I have in AAPL & DIS, using technicals to help inform which put strikes to sell at what I deemed to be staunch technical support:
AAPL, if you would like to buy at some point, but think that recent support could break at $92, and the stock is likely to fill in the gap from 2014, back towards long term support at $80, down about 14% from current levels, then you might consider dipping your toe in by selling puts instead of cost averaging in on the stock. For instance, with the stock just under 93, the October expiration 80 puts are about $2.15. On any break in the stock below this support vol should pick up and obviously those would increase in price based on deltas. That makes for a nice entry where you can establish what acts like a limit buy order while having the wiggle room of a long delta entry without having to pick the exact bottom. If the stock is $80 or below on October expiration you would be put the stock at an effective price of $80 – the price you sold the put. At the current price, that’s down 16% from current levels, which would also be a decline of about 45% from its all time highs, equal to the peak to trough decline from its then 2012 highs to its 2013 lows. If the stock is above $80, I’d say there is a very high probability as the release of the iPhone 7 in September should buoy the stock in the early Fall, then you would get paid 2.1% to merely have a resting buy order between now and then.
Looking at DIS, the chart I posted yesterday in my quarterly preview (below), is a bit of a problem, as the stock is clearly in a downtrend, at a time when eps estimates are coming down. $100 looks like weak technical support, despite the level being decent valuation support, about 17x expected fiscal 2016 eps, a tad above a market multiple. But if for any reason investors feel DIS should trade closer to the 14 P/E of CBS and TWX, then you have a stock back in the low $90s.
DIS 5 year chart from Bloomberg
Looking out to the fall and selling the Oct 90 puts (with the stock near $101) are about $1.80 and on a break below support at $100 vol should pop a little. That’s probably not a bad way to wade in the DIS pond. $80 looks like long term support to my eye. But it might make sense to start with some shorter dated July 95 puts that are $1.10 bid.
I now want to circle back and offer some thoughts on NKE & SBUX which I briefly discussed in the prior post, as both stocks are down considerably, down nearly 4% and 2% respectively, and throw in Under Armour (UA) which has some similar attributes to the group and the lower it goes ironically, may be making a strong bid to join the U.S. Consumer Teflong™ Portfolio.
Let’s start with NKE. The stock is down 8.5% on the year and down 16% from its all time highs made in December. NKE trades about 24x expected fiscal 2017 eps growth of about 15%, very near 10 year high on a forward basis. If I were inclined to start legging into a long position in NKE, I might consider the weak relative performance, and the potential for an upcoming re-test of the long term uptrend that has been in place from the 2011 lows:
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NKE 5yr chart from Bloomberg[/caption]
The next identifiable catalyst for NKE will be their fiscal Q4 earnings report in the last week of June, and the ensuing conference call and guidance should be dominated by the upcoming Summer Olympics. The lower the stock goes between now and late June the better the long set up will be into the event. This scenario could lend itself fairly well to out of the money put sales for those inclined to establish a long position. With the stock at about $57.20, the July 50 put is about 55 cents, or about 1% of the current stock price. If the stock saw further weakness that could become meaty enough with volatility popping and the change in deltas and could be a good way to dip your toe in the water with the premium sold either acting as a lower cost good til cancel order or simply a way to pick up a few percentage points if the stock were to bounce after the sale. If the stock is above $50, about 12.5% lower than current levels, then a put seller would take in that premium on July expiration. One percent is not exactly a home-run right now, but the options market is placing only a 22% chance that those puts will be in the money on July expiration. So a sale on weakness from here makes them a high probability bet for a smallish payout in a high quality name that for the time being is out of favor.
Those who are more convicted might look to extend the time of such a bet and look out to October expiration and sell the Oct 50 puts on weakness. Right now they are $1.45, which would represent about 2.5% of the stock price. But those too could become meaty if the stock were to fall closer to its January lows. I tend to prefer taking shorter time spans and just rolling the view so I would look closer in time.
On SBUX, not too different, $55 important near term support, while $50 might also do the trick as the price the stock closed just above on August 24th, the day of the flash crash:
[caption id="attachment_63563" align="aligncenter" width="600"]
from Bloomberg[/caption]
The next identifiable catalyst for SBUX will be fiscal Q3 results on July 21st. For those who might consider put sales, looking at July expiration, that will not catch earnings, the July 52.50 put is 68 cents today with the stock at $56.40 That’s about 1.2% of the stock price. On weakness those could be sold at a higher price with the worst case scenario being put the stock at $52 (less the premium taken in) That’s down about 8% from current levels today.
And lastly, UA, which has been in a free-fall since their earnings gap last month, down about 20%, and down about 30% from its 52 week and all time highs made last fall. Valuation is a concern, coupled with some recent management turnover, but the international opportunity for these guys is probably the reason to overlook such issues as only about 13% of their sales came from outside North America in 2015. I hate to say it, but $30 seems like the level on an intermediate term basis, while the Jan 20th low of about $35 could be the short term level to sell puts:
[caption id="attachment_63564" align="aligncenter" width="600"]
From Bloomberg[/caption]
With UA at $37.70, selling the June 35 puts today only yields 70 cents. But with the stock a little lower those would be a decent way to set a buy order. Right now that’s $34.30, down about 9%, and you would get paid about 2% to wait a 5 weeks. If the stock goes lower and those are sold at a higher price that percentage gets even better. For those who want to take a longer term view, the Oct 30 puts today are about $1, or about 2.6% of the stock price, down about 20% from current levels.
Rationale: When you sell puts you obviously obligate yourself to buy the stock at the strike level less the premium, as some peeps to say you get the worst part about options (decay) working in your favor. Your risk is no greater selling 1 put than it would be buying 100 shares of stock, yet your losses can be significant (but less than buying the stock unless vol went up ridiculously) on a marked to market basis prior to expiration due to increases in options prices as the stock gets closer to short strike, but this is offset by time decay. On the flip-side you do not have the upside of owning a stock, just the premium received for selling the put.
The main take-away: The risk reward of long stock vs short put looks very different, lower risk, lower reward and that’s why we prefer to sell these puts on big down days when vol is higher and the premium collected explodes a bit. We are not engaging in any of these trades at the moment, but if the stocks described above were to reach the strike levels indicated above, that could trigger us to move down the put strikes and get proactive.
In our mind put selling can be used effectively add yield to an existing long, or as a resting good till cancel buy order. And we like to use technicals to identify those levels where it makes sense.