Rolling Down and Out

Option Adjustment Strategies

Writing a Naked Put On Intel

If INTC was trading below $20/share one month later I would be obligated to purchase 100 shares of the stock for $2020, or $20.20/share (which would include the cost of commissions my broker charges me when an option is assigned to me).

But if the put was assigned to me, the net premium I received would serve to lower my cost basis. The adjusted cost basis if I ended up acquiring the shares would be about $19.73 ($2020 less the $47.25 net premium).

With an annual dividend of $0.56/share, the dividend yield on my 100 shares of INTC, based on my adjusted cost basis, would work out to be 2.84%. And if the stock closed at expiration at $20/share or higher, than I would make $47.25 from a $2000 implied obligation in 31 days. That would work out to be an annualized rate of just under 28%.

Now admittedly, these aren’t huge gains in terms of total dollar returns or dividend yield. But I consider INTC to be a high quality company with a great balance sheet, durable competitive advantages, and a long history of dividend payments and dividend growth. And I assumed that this trade was only an opening salvo in a longer campaign to acquire INTC shares.

Rolling Down and Out an ITM Naked Put

On the Wednesday prior to expiration, the stock traded in a range between $19.28 and 19.80, closing at $19.38. Even though there were still a couple of trading days to go before expiration, I didn't want to wait and take the risk that the stock might continue falling.

Now considering that I really was trying to acquire these shares of INTC (but paying as little as humanly possible), I basically had three choices:

1. Choice 1 was to do nothing and allow the put to be assigned to me. This would give me that predetermined $19.73 cost basis and 2.84% yield. I didn’t like this choice because the stock was already trading below my adjusted cost basis. And fortunately, there were better choices.



2. Choice 2 was to roll out, buying the December put at the $20 strike price and selling a new put expiring in January at the same strike price. This would generate additional net premium gains since I could sell the January put for more than it would cost to close out the December put. By doing this, perhaps I could knock the eventual cost basis of any acquisition down from $19.73 to something around or even below $19.50.
   
   Choice 2 was superior to Choice 1, but as much as I do like INTC, I’m aware that this is a chip maker after all. While I consider INTC to be a world class business with considerable structural advantages, the stock can still be volatile. So what happens if the stock continues to fall? What happens if it’s down to $17 or $18 at the January expiration? Remember, the deeper in the money a stock is, the less extrinsic or time value will be left on the corresponding option.



3. Choice 3 — and the one I decided on — was rolling down and out. On 12/16/09 I bought back the December $20 put (with commissions) $74.74 and sold an April $19 put for $121.24, netting me a credit of $46.50.
   
   Now, if the stock is trading below $19/share at the April expiration date, and I allowed myself to be assigned without making any additional rolls or adjustments, to calculate my new adjusted cost basis, I would take $1920 I would have pay (which includes my commissions for being assigned the shares) less the total net premium received to date ($47.25 + $46.50, or $93.75) which would result in a total investment of $1826.25, or $18.26/share. That would then increase the dividend yield to 3.06%.
   
   This was the most conservative of the three choices and gave me better protection to the downside..It’s interesting to note that both puts provided almost identical amounts ofpremium, but the initial holding period was only one month whereas the rolled position required holding for four months.