Andy Sirski’s been studying bull put spreads. In this column, he tells you how it’s working for his portfolio. And, a tribute to John Clark
A lot has happened since my last column. For one thing, the Dow Jones Index came up to 14,009, within a hair of the old high set in October 2007.
A lot of good stocks have made a lot of money these past 63 months. Some would call this a bull market, but most bulls don’t last much longer than this so many wonder what will happen next.
The price/earnings ratio has dropped from about 16 to 13. The drop is partly due to the negative sentiment surrounding stocks. It will take time for retail investors to get over that negative mood.
Odds are, we’re getting closer to the time when interest rates will rise. As that happens, many bonds will start to drop in value in North America. As bondholders start to give back gains, many will start to move money from bonds into some other investment. At least some of that money will go into stocks.
But I don’t see volatility going away. I’m quite sure we will see money move into one or two or three sectors, drive up prices, then sell out and move to other sectors. As I write on February 4, I think we can see money moving back into silver and gold stocks. They have been beaten up and most of the time money that has ridden up stocks in one sector can’t resist moving into a beaten up sector. Gold and silver stocks are certainly cheaper than they were months ago.
At the same time I hear the cost of running a mine is going up eight to 10 per cent per year — that translates into about $100 an ounce for gold mines. When I mesh rising costs and a more subdued rise in the price of gold and silver, most miners likely have a lower high facing them than a few years ago.
So where is the price of gold and silver headed? I don’t really know but central banks around the world are buying up gold, which basically takes it out of circulation for years. Plus, rich deposits of gold are harder to find so there likely is some sort of floor under the price of gold, and hence silver. And silver is used in small amounts in many gadgets and so gets thrown into the garbage for now.
In early February Pfizer (PFE) spun off its livestock division. Shares were listed at around $26 but quickly jumped to $31. Most initial price offerings (IPOs) don’t stay up in price once the first flurry of buying is over. Then we have a thing called “shares owned by insiders” that are locked up for up to six months and as that deadline passes, insiders often sell at least some shares.
However, this spin off is about a $4 billion dollar business around the world, in 60 countries and with 9,000 employees so it’s no slouch business. I don’t usually buy IPOs so I will watch for now.
Bull put spreads
I’ve been studying how to do bull put spreads.
This is a strategy for flat to bullish markets so it takes some understanding of the market. The big advantages of bull put spreads are you don’t have to own the shares and it cuts down the amount of margin money (I call it put space) you need to have in your trading account.
A lower margin requirement can do two things. First, it lets you work with more stocks, which theoretically should reduce risk. Second, investors with smaller accounts who learn this stuff might be able to get approval to do bull put spreads.
With these spreads you don’t have to own the shares but you should learn the strategy. I wrote in an earlier issue that by the time you read this article, I will have done several spreads. So here goes.
The idea is that you choose a stock you wouldn’t mind owning if the shares were put to you (that is if you had to buy them).
When you sell naked puts you become the insurance company. If shares drop below the strike price you sell the put at, you will likely have to buy the shares.
Let me back up. First, I had 7,000 shares of TCM that cost around $3 per share. I sold them for $4.20. Last October I sold naked puts on 5,000 shares of TCM with a strike price of $4 for April, and collected $1.10 per share. Then I bought those back for $0.31, and cleared a few grand. Now I don’t own any shares and have no naked calls.
I figure/hope the shares might, should, could stay over $4 so I might not have to buy them. And if I did have to buy them my cost would be $4, minus what I collected from the bull put spread. I know I might have lost some readers by now, but others are quite interested so bear with me.
When you do a bull put spread, you sell the expensive put and buy the cheap put.
For March I sold the put with a $4 strike on 5,000 shares and collected $0.26 per share. Then I bought the March put with a $3 strike price and paid $0.07, so I cleared about $0.19 per share on 5,000 shares. Subtract commissions and my net was around $880 for not quite two months. And I only used about $4,200 of margin (put space). Remember, I did not own the shares and still do not as I write. So far, TCM is above $4 so we are not committed to buying those shares at this time.
Then I looked at Sherritt. I already own 5,000 shares at an average cost of $5.63 and I wouldn’t mind buying a few more.
I did the same strategy as I did with TCM. I sold the expensive put, strike price $6, and collected around $0.21 or $1,000 after commissions. Then I bought the cheaper put, $5 strike, also for March at a cost of around $0.06. I cleared around $715. Those shares have dropped to $5.88 so I might end up buying them. The paper cost would be just under $5.90, which, in my opinion, wouldn’t be so bad.
This is all part of my education on this strategy. I have no idea exactly how things will turn out. If both shares end up or get above the strike price I sold at, I’ll keep the $880, plus $715 for a total of $1,595.
Since I’ve committed about $8,500 of margin money, the two deals could make me about 18 per cent for not quite two months. I suppose the worst case scenario would be that I’d have the money but would have to buy the shares, which likely would be okay too.
Of course, I could then sell the shares, or sell covered calls on them and collect more cash.
The thing with doing spreads at these cheaper stocks, say under $10, is that there is very little wiggle room if the share prices drop. On the other hand, if I do spreads on $10 or $12 stocks, if the shares drop I can usually buy and sell my puts, and repeat the strategy at a lower strike price and not be out any cash.
I chose TCM and S because I wouldn’t mind having to buy those shares and because the premiums were quite good. Sometimes rich premiums suggest the share prices might fall, but I can’t seem to find positive proof of that.
As far as put space is concerned, between TCM and S I’ve used maybe $8,500 of put space which leaves me a lot of margin money if I decide to do more of these. I’m going slow to give my brain a chance to learn, study and absorb and to see what happens.
If some of this stuff boggles your mind, don’t sweat. I had the same problem for months with selling covered calls and I just kept poking away and finally had a couple of those “aha” moments and slowly things fell into place. Now they are almost second nature to me.
As associate publisher/editorial director John Morris wrote in the Wheat and Chaff section of the last issue of Grainews, John Clark died January 18, 2013 at the age of 81.
John Clark started Grainews in the early 70s partly to keep canola out of the Canadian Wheat Board and partly to have a way to publish more information about how to farm. Grainews became famous as the farm paper that had farmers write for farmers.
I joined Grainews in early 1979 mostly because I knew farming, taxes and investments. John Clark figured it was easier to teach a farm boy how to write than teach a city boy about farming. Roger Olson, John and I had a great time running Grainews for years. At the risk of missing someone, Inez, Carole, Heather, Jacqueline, Tom and Gunny helped run the place. Some of us retired, some moved on and some still work for Farm Business Communications.
The interesting thing is this: three significant Grainews contributors: Alf Bryan (deceased), Boyd Anderson and Harvey Gjesdal were dedicated writers for years. And all three had children take over the farm.
In the storybook of life, I hope all of us have at least a page, a chapter or several chapters that stand out. I think John Clark had several outstanding chapters. He helped raise a fine family of four. My condolences to them, to his grandchildren and to his wife Colette. John loved the outdoors and he loved farming and the farming industry. I’m sure many farmers will join with me to say, “Thanks John for your contribution to the industry.” †