How to Snap Up Global Stocks at Discount Prices
Selling cash-secured put options is both simple in execution and relatively low in terms of risk.
But here's what most investors don't realize: While it may be hard to find truly undervalued stocks, there's a way to buy perfectly valued shares at a substantial discount to their market price.
At times, that discount can equal 20% or more.
What's more, this strategy can be utilized in virtually any market environment. It doesn't matter whether the bulls are running the show, as they have been recently, or if the market is suffering from a "fiscal hangover," as it was in early 2009.
The technique is known as "selling cash-secured put options" -- and, while trading options is viewed as complex and scary by many investors, this particular play is both simple in execution and relatively low in terms of risk.
Here's how it works:
Assume you've decided you want to increase the international exposure in your portfolio, but only under two conditions:
- You don't want some obscure foreign stock
- And you'd also like some added dividend income
You've looked at several companies and you think Kraft Foods (KFT), a leading producer, packager, and distributor of quality food products meets both of those requirements.
After all, the Kraft brand is quite well-respected worldwide. The company, in its last full fiscal year, got 42.8% of its $41.93 billion in revenue from international sales, with $8.24 billion (45.8%) of that coming from developing countries. Sales from those fast-growing markets are likely to rise sharply in the months and years to come as the global economy continues to recover and the growing ranks of middle-class consumers in those nations demand more modern grocery stores and food products.
Kraft shares also pay an annual dividend of $1.16, a yield of roughly 4.18%.
But here's the thing. With Kraft's proposed buyout of Cadbury (CBY) still creating some uncertainty, you feel the stock might be a bit overvalued at a recent price of $27.72 a share. You believe that $26.00 a share represents "fair value". But how can you get the stock at that price?
Let's assume you were planning to buy 300 shares (the minimum I recommend for this strategy), and thus have at least $8,316 in available cash. Rather than using that to buy Kraft stock at $27.72, you post it as security for the cash-secured sale of three Kraft June put options with a "strike price" of $26.00 a share. (Each standard option represents 100 shares of the underlying stock, so three puts would equate to 300 shares).
As the seller of three June $26.00 Kraft puts, you give the put buyer the right to sell to you 300 shares of Kraft Foods stock at a price of $26.00 per share any time up until the expiration date, which in this case would be June 18, 2010. In exchange for selling this right, you receive a "premium" (payment) from the option buyer of $1.00 per share -- or $300), which you can either take out or use to reduce the $8,316 security deposit on the "cash-secured" transaction.
Now what happens?
For you, there are three possible outcomes:
1. If Kraft's stock price rises before mid-June, the puts you sold expire worthless and you get to keep both your $8,316 and the $300 premium you received. You don't get the shares, but you've made a 3.61% return on your money in just under five months -- without owning the stock. Plus, you can repeat the put sale in June, using options that expire in September or December of 2010.
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