Sunday, January 15, 2006

Value Investor Writing Put Options? A Heretic!

You can say I literally stumbled into Put Option Writing several years ago. While trolling for value plays, I came across many stocks with good risk reward characteristics and attractive valuations. But for qualitative reasons, they did not fit my core portfolio. Almost serendipitously, I discovered that this group of stocks almost always comes with options that carry high implied volatility and hence high prices. This condition favored option writers rather than buyers.

When I first thought through the Put Writing strategy, what struck me was that Put Option writing gave me an opportunity to buy stocks below market, which gives me an even greater margin of safety. Furthermore I will be paid to wait, with time decay working in my favor. Since 95% of options eventually expire worthless, it was no surprise to me that when I eventually converted this strategy into actual trades; they turned out to be high probability trades.

On reflection, this strategy leans more on Benjamin Graham and away from Buffet's thinking. It is more cigar butt investing, more on valuation and less on moats and buying great companies. This strategy requires more diversification, less emphasis on circle of competence. Important thing is that it works.

Not A. Lemming


Anonymous Anonymous said...

I don't understand your "heretic" comment or your "away from Buffett's thinking" comment. Mr. Buffett sold a bunch of Coke puts in 1993 (you can read about it in Andy Kilpatrick's book).

2:57 PM  
Blogger Not A Lemming said...

I don't recall reading Mr Buffet selling KO puts, if you could kindly provide the page, I will dutifully read it.

In any case, his intention of writing the puts is to the buy the stock. I write to collect the premiums, getting the stock doesn't hurt but I rather not get put.

The only Heretic I am refering to is myself. Burn me at the stakes!!

6:33 AM  
Anonymous Anonymous said...

Mr. Market,

Given that volatility (as measured by the VIX) is near lows and that interest rates are, also, near lows even though the Fed has raised the Fed Funds rates multiple times last year, why on earth would you be a writer, i.e. seller, of options?

Given the above, the "time value" of options is abnormally low. Therefore, if one is bullish (which, I assume that you are), instead of writing puts, one should be purchasing calls.

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