Option Enhancement
Another portion of our investment philosophy that separates us from most value managers is our ability to generate additional income and strategically establish and sell out of positions effectively via options. Occasionally, there are times we may see reasons to employ options strategies, including, but not limited to:
- Covered Calls
- Cash Secured or Naked Puts
Kraft Illustration
Below is a price chart of Kraft from January 2003 to the end of December 2006. Suppose you were willing to purchase Kraft at $30/share on January 30, 2003, and sell at $35/share on September 26, 2006. With dividends reinvested, your return over that period would be 6.65%. Now suppose, instead of purchasing and selling shares outright at market prices, you decided to use option enhancement. Through this illustration, by selling naked puts and covered calls, your effective purchase price becomes $27.75 and your effective sale price becomes $38.95. Note, this sale price is higher than any price ever achieved in the market over that time frame!
And here is the detail for the total return calculations:
No Option Enhancement Trades
| Date | Action | Price | Shares | Total |
|---|---|---|---|---|
| 1/30/2003 | Buy | $30.00 | 1000 | $30,000.00 |
| 9/26/2006 | Sell | $35.00 | 1000 | $35,000.00 |
| Stock Price Appreciation | 4.30% | |||
| Total Return | 6.65% | |||
Option Enhancement Trades
| Date | Action | Price | Shares | Total | Effective Price |
Price in Market on that Date |
|---|---|---|---|---|---|---|
| 1/30/2003 | SellX30.00 Put | $1.50 | 1000 | $1,500.00 | ||
| 3/10/2003 | Sell X27.50 Put (expired) | $1.50 | 500 | $750.00 | ||
| 4/18/2003 | Buy (Assigned) | $30.00 | 1000 | $27,750.00 | $27.75 | $29.75 |
| 11/18/2004 | Sell X35 Call (expired) | $1.50 | 1000 | $1,500.00 | ||
| 1/10/2006 | Sell X27.50 Put (expired) | $1.50 | 500 | $750.00 | ||
| 9/26/2006 | Sell X35 Call | $1.70 | 1000 | $1,700.00 | ||
| 12/15/2006 | Sell (Assigned) | $35.00 | 1000 | $38,950.00 | $38.95 | $35.71 |
| Stock Price Appreciation Return | 9.70% | 5.11% | ||||
| Total Return | 12.05% | 7.46% | ||||