CSP Example: WFC

Note: I wrote this memo for private consumption about a month ago. With the decline in WFC, I have re-established a short-put position.


I just got off a 118 day cash-secured put campaign on Wells Fargo. I pegged WFC’s worth at about $60 or more, and it has been trading in the $51-56 range since April.

It isn’t rich enough for me to write covered calls on, or cheap enough for me to add to the position directly (I require a margin of safety of 20%).

wfc_csp

On April 10, I wrote 1 $54 put 25 days out (5/5 expiry), when the stock was trading at $54.42. After earnings, which came out right away, the stock dropped to $51.53, when I wrote another put $52 put, expiring 5/12. I booked premiums of $128 and $158, after commissions.

On 5/5, the stock traded above $54, and the first put expired worthless. On 5/12, the second put also expired OTM, with the stock trading around $53.

I immediately wrote 2 more $53 puts ($128), and rolled them over twice. Once on 5/25 ($174) and 6/8 ($126). On July 14, the stock ended above $53, and I let the position expire.

Overall, I collected $714 in premiums after commissions (on $10,600 cash outlay) over 118 days, for an annualized return of 33.5%.

This campaign reduced by effective buy price to $49.50, even though I ended up not buying any shares.

If WFC falls to $53 or below, I will probably embark on a new CSP campaign.

 

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The Allure of Cash Secured Puts

Recently, I wrote an example of a CSP campaign on VFC.

The ideal layup for CSPs is the following:

  • you are interested in a liquid large cap stock,
  • options on the stock are available and liquid,
  • you have done a valuation and price is below the intrinsic value,
  • however, (intrinsic value – price) > margin of safety,
  • the stock has fallen in the recent past (greater implied volatility),
  • you have tons more cash than ideas.

Let’s consider my campaign on VFC, and how it ticks many of the conditions above.

Liquidity

VFC is a large liquid large cap stock. Its market cap is ~$21B, and nearly 3M shares trade every day. Monthly options are available on VFC, and the ATM calls have a daily volume of a few thousand. Bid-ask spreads on such options are usually between 5-20c. While this is not as liquid as a megacap like Wells Fargo or Apple, it is sufficient.

Valuation

I did a valuation of VFC, and determined that it was worth somewhere between $55-$70. Lets pick $65 as a point estimate of the intrinsic value. I like to buy stocks with at least a 20% margin of safety.

Thus, I would be interested in VFC at 80% * $65 ~ $52. Since VFC is a reasonably safe, unexciting, range-bound stock, which pays a 3% dividend – I really don’t mind buying it around that price – although I would really like to buy it under $50.

Environment

Two years ago, VFC used to trade over $70. In the past year, its range has been $48-$65. Thus, it has had a somewhat rough time.

At the same time, the overall market is going gangbusters. I haven’t found too many new opportunities. My cash balance is over 35% of my portfolio. The only stocks I have bought in the past six months are OAK, FFH.TO, and ALJJ. I have liquidated a lot more. I don’t mind diverting a small part (say 25%) of my cash balance towards CSPs.

Advantages

CSPs open up the universe of investable ideas. For ideas where there is insufficient margin of safety, it provides a method to work out a reasonable cushion by embarking on a campaign that can last several months. It lets you lower the effective buy price below what the market offers over that time period.

It also helps psychologically.

I know we are all supposed to be patient and wait for the really fat pitches. But the wait can be really hard and exasperating. It gets harder as you continue selling positions that have risen above your estimate of fair value, and the cash keeps building up. Furthermore, if you are adding external cash to your portfolio like me, it just compounds the aggravation. All that cash has nowhere to go.

CSPs help alleviate frustration, by keeping you productive and busy. They increase the size of the available opportunity set. They prod you to keep looking. If done carefully, they either lower your effective buy price, or help you collect some income on the side, while you wait for the market to swoon and offer better opportunities.

Either way they prevent you from splurging on something overpriced, or going crazy.