SCA puts closed for a profit

Around a month ago at the end of August I suggested that there could be a put selling opportunity on SCA stock here. At the the time it was trading around 169 SEK, was near 52-week lows and had previously traded in a range of 165-160 SEK.

I decided to sell the two months out October 165 puts for 2.40 SEK but modified the strategy a bit by buying the October 150 puts for 0.4 SEK (this is now called a 'put bull spread'). This protected my downside, as these puts would increase in value if the share price fell below 150 SEK, and fixed my maximum loss to 1500 SEK per contract (i.e. (165-150)*100).

Total income per contract (100 shares) was (2.4-0.4)*100=200 SEK for the two months, 13% return on the money 'at risk'. Although to be fair this does not really accurately reflect the true return, I prefer to calculate using the money that would be required to buy the shares at 165 SEK if assigned. In this case the return would be 200/16500=1.2% for the two months, 7.3% APR.

Since then the share price fell a bit but never touched the 165 level and has recently had a nice run up to 177.5 SEK.

After a month the premiums on these October puts has fallen to just 0.25 SEK so I bought them back to close the trade. I didn't think it was worth keeping it open for another month for so little money and it would be better to use the money on other opportunities.

Total income was 175 SEK, 1.06% per contract but was over the 1 month instead, thus increasing the APR to 12.7%.

Put Selling Opportunity: SCA

Svenska Cellulosa SCA is a Swedish company that is one of the worlds largest in personal care products (e.g. babies nappies), the third largest supplier of tissue (e.g. toilet and kitchen paper) and one of Europe's most profitable producers of forest products.

The current stock valuation is around P/E 17, EV/EBITDA 12 and it pays a 2.8% dividend which has been growing nicely since 2010. Below is a chart of the share price from the past year.

The stock reached a peak around 200 SEK back in Jan and has been steadily falling since then and is now close to its 52-week lows. If however, we go back 2 years we can see there was a big run up at the end of 2012 before consolidation around 160-165. 

This look an interesting area for selling puts in SCA. At this moment the October 165 put can be sold for around 2.15 SEK or the 160 put for 1.05 SEK. The choice depends on how happy the investor is happy in holding SCA stock if assigned (the latter of course being less likely).

If the stock falls to these strike prices then the puts could be bought back and then rolled out to the next month and down at the same time. For example this would mean buying back the Oct 160 put and selling the Nov 155 put. This then would put the strike price of the option below the consolidation zone mentioned before. If the stock price then stayed above 155, the put would expire worthless and the investor would keep all the premium. Further declines would require further rolling down of the puts and potentially other strategies to keep the trade profitable.

An alternative strategy would be to accept the shares and then immediately sell a covered call to bring in more income. For example if assigned shares at 165 SEK, 'at the money' calls with strike price 165 would be selling for around 2.75 SEK for a month out. Adding the premiums from the put and call would total 4.85 SEK giving a cost price for the shares of 155.15 SEK. The shares would then be called away if the price finished above 165 at the end for the month.

Put Selling Income: Sandvik

Selling puts is a excellent strategy for generating income and building capital. The key is to avoid speculative companies and focus on stabile large cap stocks that ideally pay a dividend. We're pretty much talking about the stocks that many investors find boring!

This is important because if you are ever 'put' the stock (i.e required to purchase shares at the strike price) you must have confidence to hold the stock and that the price will eventually recover so you will at least get your capital back. Large cap dividend payers don't usually disappear quickly and the dividend provides a cushion to your investment.

As it is, most options in Sweden are only available on large caps anyway so the temptation to bet on the twitters and facebooks of this world is not possible. For example Sandvik is a global engineering group that i) sells tools and equipment to the mining and constructions industries ii) is a world-leading developer and manufacturer of products made from advanced stainless steel grades and special alloys for the most demanding industries.

In the current rolling year it had 85000 MSEK ($12.4 billion) in revenue and made 4700 MSEK ($685M) in profits; although these are falling from 2012 highs which explains the stock price action. The company has a large exposure to the mining industry so business is being affected by the current downturn. It has a P/E 22 and pays a dividend yield of 4.1%. Expected profits for the year are 5.41 SEK per share giving a P/E 2014 16.6 at the current price of 85.4 SEK.

Below is a weekly chart of the share price over the past three years.

The price level of 80 SEK looks interesting; 5.8% below the current price. The stock last touched here in June 2013 before going sideways the past year between 85-95. Before that we have to go back to end of 2012 when Sandvik was selling at 80 SEK. 

Last week I was able to sell the Nov 80 put for 1.5 SEK. This means for every contract I sold (100 shares) I received 150 SEK but must be prepared, if assigned, to buy Sandvik stock at 80 SEK, costing 8000 SEK per contract, in the coming three months. This is a return of about 1.8% on my capital, 7.5% per annum.

It's not big money but I already have capital committed to other investments so instead of the usual goal of 1% per month I wanted a lower risk of assignment, so aimed for 0.5% return per month. However, the margin requirements to keep this trade open are roughly about 20% of the total (e.g. 0.2 * 8000 = 1600 per contract) increasing the return to a 'hypothetical 37.5%' per annum.

I say a 'hypothetical 37.5%' as it would be asking for big trouble to fully use the margin available all year round for these type of trades. A quick down turn in the market could mean being put a lot of stocks, more than you can afford and then a dreaded margin call.  Nevertheless the margin is available for use when required and comes interest free.

I have also decided to avoid being assigned Sandvik stock, I would rather use my capital for other investments, so if the stock price does reach 80 SEK, I will buy back the puts (most likely at a loss) then roll them down by reselling them at a lower strike price e.g. 77.5 SEK. I will also have to go further out in months to Dec or Jan to get my money back and keep the trade profitable.

The 'worst case' scenario is I unexpectedly get put stock early. I can either resell it and sell the puts as mentioned above or immediately sell covered calls to continue generating income. If the stock continues to fall I may have to apply more capital and/or other option strategies to get my money back and ideally still create a profit.