How Selling Puts Can Create A Huge Margin Of Safety

During their recent episode of the Value Options Letter and Acquirers Podcast, Travis and Tobias discussed How Selling Puts Can Create A Huge Margin Of Safety. Here’s an excerpt from the episode:

[Travis] This is a trade that we actually just set today, charter communication. So this is a very beat up stock, not a stock that we’ve invested in in years, actually. And excuse if you hear some coughing in the background, my eight-year-old daughter is battling a little bit of a cold.

So excuse that. So charter operates one of the largest cable and broadband networks in the United States, very capital-intensive business that cannot easily be replicated. And the stock’s corrected dramatically from its 52-week high.

So conservatively, we think the stock’s worth $175. This was a stock trading at over $300, $400, not that long ago. And they were buying back stock at those levels run by John Malone back in the day, who’s known as a very astute asset manager.

But those stock buybacks were a mistake in retrospect when you see kind of what’s occurred and the debt that was taken on. But we’re starting from a cheap stock. So our fair value estimate is $175.

The stock today was trading at $144.80. We’re going to deal with the $100 strike. So what you can do is you can sell that $100 strike and collect $8.15 per share premium. The days to expiration is 2-34.

So our effective yield is 13.8%. That’s the annualised rate of return we’re targeting. If we end up owning this stock, our breakeven is $91.85, which is 48% below the fair value. All right.

So huge cushion, already a cheap stock, already down huge. There’s a lot of option premium because it’s been volatile. But this is not like a business that’s going away in the very near term.

These are very valuable assets that are tough to replicate. And so we’re creating a 36.6% cushion below the current price. So a bear market is defined by a 20% downturn.