Real Options Trades: Covered Calls on Blue Owl and Puts on ServiceNow

During their recent episode of the Acquirers Podcast, Travis and Carlisle discussed Real Options Trades: Covered Calls on Blue Owl and Puts on ServiceNow. Here’s an excerpt from the episode:

But so let’s go ahead and get started. So Blue Owl. Blue Owl is an asset manager that has been in the news a lot over this past six months.

And what I like about them is they’re a $300 billion alternative asset manager. So 85% of that capital is permanent or long duration. And that’s huge because that means that the management fees are really locked in to a large standpoint.

And so it’s not a business that’s just going to go to zero in two years. It’s a franchise that continues to compound over different cycles. They’ve had good performance in their strategies.

We like the business a lot, actually, even though it’s out of favour. I think that a lot of the headlines have been a little bit misleading, to be honest with you. So we’ve got this opportunity.

How are we going to take advantage of it? Well, we’re going to show a covered call example. So we’re going to buy 100 shares of Blue Owl at $10.27, which is where I was trading at at the time. And then we’re going to sell a short term, 44 days out June call at $11. All right. So like with all of our strategies, there’s really two things that can happen.

So heads, if the stock expires above 11 on June 18th, then you’re going to end up making a really healthy profit of $35 from the option premium plus the upside on the stock from $10.27, so 73 cents on that, plus the $35 premium. So it equates to about $108 or 10.9% target profit, 90.3% annualised. So those numbers are important.

10.9% return on your maximum risk in 44 days. So that’s a really compelling element of options. Yes.

Let’s say Blue Owl goes to 14. Well, you wish you would have just held the stock depending on the timing of which that occurs. But that’s why we talk about, there’s strategies where you own a thousand shares and you sell calls on some of them or whatever, but it’s a hell of a return in a really short amount of time using a tool that reduces the risk.

And so the other thing we like is that if the stock doesn’t go above 11, we just manufactured about a 3% premium on top of the 8.56% dividend yield that Owl already pays. So really between the premium on just 44 days and the dividend, that puts you at double digit on an annual basis returns, but we can keep selling calls if we want to, if that option doesn’t get exercised. So that’s the first example, Blue Owl.

Second one, ServiceNow. So this is definitely not your quintessential value stock because this is high growth, high, high, high growth. This is a company that is critical to IT infrastructure.

They’ve been growing their revenue at levels that very, very few companies have done in the past to where they’re quite sizable now. And this stock, which is critical in IT infrastructure and AI implementation has been sold off on fears that software is going to be dramatically hindered by AI. And so we think that that’s actually created opportunity.

So this is a stock, the 52 week high is $211. And when we sold the put, it’s trading a little over 80. But so what we did was we sold a $70 put on ServiceNow and we collected a premium of $5 and 45 cents a share.

So $545 total. And that option expires in November. So it’s 199 days out, little over half a year.

And once again, the stocks above 70 at expiration, you’re going to make 8.4% on the maximum risk, which is 15.5% annualised. All right. And that’s a fantastic return.

Like I’ve mentioned before, we normally are targeting double digits. Worst case scenario, we end up owning ServiceNow, a stock with fantastic future growth prospects at 15.8 times forward adjusted earnings versus their historical average of 38 times over the last five years. That’s where they’ve traded at.

I mean, this was a glamour stock. So we’re very comfortable owning it there. It’s adjusted earnings.

So stock-based compensation is part of it, but these are the same metrics. It’s 15.8 versus 38 times adjusted earnings. So that is an example of how you can utilise that.

And if people don’t know this company, it’s really category defining in terms of enterprise workflow and IT service management. It’s got mid thirties operating margins and it generates a tonne of free cashflow. It’s used by the vast, vast majority of the Fortune 500.

So that’s an example of how you can use these strategies on a growth day.

[Tobias] And just one way of reading this, just go back to that slide Tim. There’s one way of reading the slide or this slide, it doesn’t matter. It’s showing you one unit of exposure is $6,455.

Your gross return is 8.4%, which annualizes to 15.5%. And then we’ve got the value metrics at the end. So you’re able to look at these positions and ascertain whether that return is sufficient, whether you like that annualised return. And then you should understand your risk profile, which is that if the stock goes down, it will be put to you, but then you’ll be buying at a cheaper price.

And if it’s a stock that you’re prepared to buy anyway, then that’s a good outcome because you’re getting it at a lower price. So the two outcomes are you take the yield without having to take the stock or you take the stock at a lower price. And if either of those two outcomes are acceptable to you, then it’s a good trade for you.