Value Options: Options 101 for Value Investors: Everything You Need to Start

During their recent episode of the Acquirers Podcast, Travis and Carlisle discussed:

• Cash-Secured Puts Explained: Get Paid to Buy Stocks at a Discount

• The Options Wheel Strategy: Generate Income With Puts and Covered Calls

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

• Selling Put Options on Undervalued Stocks: Fiserv and Alexandria Real Estate

• How to Evaluate Options Trades: Risk, Return and Capital Protection

TRANSCRIPT

Options 101 for Value Investors: Everything You Need to Start
[Tobias] Hi, I’m Tobias Carlisle. Welcome to the Value Options Letter podcast. I’m joined by my co-host Tim Travis.

He’s going to take us through the Value Options Letter presentation. Take it away, Tim.

[Tim] All right, so let’s get into it. Let’s show some specific examples of trades that were sent out to Value Options Letter subscribers. That’s where you can find us, valueoptionsletter.com.

Let’s go ahead and get started. So let’s talk about why we’re doing this and what this subscription service offers. So most options content teaches you specifics on how to trade, and most of it’s geared towards buying options, buying puts, buying calls.

And it sounds sexy because if you buy a call on Nvidia and Nvidia doubles, you make a tonne of money and you’re only laying out that premium that you’re paying to buy the option. But what’s not talked about enough is you have to be right on the timing of it, and you have to be right on the direction of it for that to happen. And so that’s why a lot of people refer to buying options as being the player at the roulette table versus the selling of option as being the house.

So that’s a key difference is generally when we’re utilising options, we’re selling options, but value options, which is the key critical aspect of it. So a lot of advisors, and this is a subscription service, not an advisory, but they don’t use options at all. And there’s tonnes of reasons why.

Usually they don’t know how to do it. Their focus is just on kind of raising assets. Large firms like Merrill Lynch or Morgan Stanley or Fisher Investments, they’re not interested in really having an advisor or clients doing covered calls or cash secured puts because it makes their jobs harder.

They have to monitor it. You have to explain it to all the people involved. It’s just not part of their business model, even though that it can be really good for clients and for investors.

So the business model rewards just kind of gathering the assets rather than really focussing on the money management element of it. So the reason why Value Options Letter exists and why it’s such a great value add for do-it-yourself investors is that the way that we utilise options is grounded in that deep value discipline. So every stock that we’re engaged in are trading at discounts to our estimates of intrinsic value based on a variety of metrics.

And as you mentioned before, Toby, the same framework’s been used by the best investor in the world. I mean, Warren Buffett did this. He did it on both index options and he did it on Burlington Northern Santa Fe and Coca-Cola.

And it’s not really talked about. That’s what I always found interesting. It was always kind of like a little blur or maybe you’d see it in like the annual report, but it wasn’t like, well, shoot, Buffett’s doing this.

Like, why aren’t I doing this? And that’s really kind of the difference. So the framework here.

Cash-Secured Puts Explained: Get Paid to Buy Stocks at a Discount

So there’s several different strategies of option strategies that we utilise at the Value Options Letter. So the first one is cash secured put. This is probably the most common strategy that we’ll utilise.

So basically what we’re doing is we’re selling a put at a strike where you’d happily own the stock and every option correlates to a hundred shares. Okay. And so the way it works is you get paid the premium up front and the cash reserved is your total put exposure.

So if it’s a $50 stock and you collected $500 of premium and the strike is $50, you’re obligated towards $5,000, which is 50 times a hundred minus the $500 premium. So your cash allocated would be $4,500. That would be your exposure.

So we’re not talking about using any leverage, none of that kind of stuff. And so basically it’s just the flip of a coin, heads or tails. That’s what I like.

The way that the Value Options Letter utilises options is simple. I mean, it’s not complicated. You don’t have to read all the charts.

That’s not our game. That’s not what we do. So heads, if the stock’s above 50 in this example, you make 500 bucks.

If the stock’s below 50, you end up owning the stock at 50 minus that premium. So your break even is 45. So that’s the cash secured put.

Covered call. All right. So covered call is you either own the stock already or you buy the stock and simultaneously sell a call on it.

Okay. So you’re selling the call at a price that you’re willing to sell the stock at. So if you think that Amazon is worth, let’s say $350 and the stock’s trading at $270, you might not want to sell a call at $275.

But if you may be going further out in time, you can sell a call at $350 and still get a really good premium. So you want to do this at prices you’re willing to sell the stock at. And basically that premium adds yield to a position you’d hold anyways.

So often we’ll see stocks pay four or five, six, 7% dividends. And then by selling a call, we’re able to manufacture a double digit income yield. So the premium plus the dividend income combined is often over double digits.

And then you have upside on the stock going to where you wanted to sell the stock at, where you were willing to do that. So covered call is very effective strategy. Key points on all of these are stock selection.

That’s what the value options letter provides. It provides both the stock selection and the strategy. Lastly, we’ve got leaps.

So these are just the same as cash secured puts, but going a little further out in time. Okay. Because our overall investment discipline is value investing.

It’s long-term orientated discipline, but it’s the tactics are utilising options. So options to generate income, reduce risk, and instil a disciplined practise at buying stocks cheaper and selling stocks where you want to sell them at. So it’s just longer term.

It’s nothing too complicated. So those are it. That’s it.

You don’t have to be an MIT professor to understand the simple and what I believe are the best ways to utilise options.

[Tobias] Yeah. So one of the things that I love about these structures is that if you have an idea of the underlying intrinsic value of these companies, then options allow you a way to express that view in the market very simply. And you can see where you’re buying, which would be a better price than the stock is trading in the market, where you’re selling, which should be a better price than where the stock is trading in the market.

And then you look at the premium that you receive and you can make sure that you’re getting sufficient return for taking on either of those positions. And so it’s like an underwriting handicapping approach that allows you to express views in stocks where the stock may not be at the price that you want it to be, but you can see option strikes that get you to those prices.

[Tim] Nice. And what you know as a long-term orientated value investor is that predicting the timing is often the hardest part. I mean, it can be frustrating.

You can be right on direction so many times. I mean, we’ve both been right so many times, but if you’re waiting 18 months, that can be very frustrating. But the cool thing about this is you can be selling puts on that name and be generating income the whole time.

The Options Wheel Strategy: Generate Income With Puts and Covered Calls

You keep reloading the gun. So it’s a total game changer. So what I also love is what we call the wheel.

Okay. So there’s other videos where you could find stuff about this, but this is a no brainer strategy when you tie it in with value investing. So basically step one, we’re going to sell a cash secured put.

Once again, company we want to own at a price that we want to own it at. Heads or tails, either the option expires, you make your return. We almost always target double digit annualised returns.

That’s normally the return hurdle. There’s some small examples for really safe, what we believe to be safe investments, but usually we’re targeting double digits. Expires, you make that double digit return.

If you’re assigned, then you end up owning the stock at cheaper prices and you’ve got all the upside or downside on the stock plus the dividend. So now that you own it. Okay.

So let’s say in the wheel example, you own it. Now, what are we going to do? We’re going to sell a covered call.

So you’re getting the dividend. You collected that premium already, which reduced your cost basis on the stock. Now we’re selling covered calls above your cost basis.

So we’re generating additional income. And once again, there’s two things that can happen. Either your stock expires above the strike price and you get called away, locking in a great profit, or you end up selling another call and you can keep doing the wheel.

So it’s a fabulous cycle. And the thing is, Toby, as you know, I mean, as someone that’s been in this business for a long time and same here, it’s hard for do-it-yourself investors that are focused on their job, their employment, their family. How do you have time to do all this, right?

So it’s not easy. And then it’s like, okay, well, now I’m exercised, which options do I sell? Has the intrinsic value changed in that time?

So the cool thing about the value options letter is that it keeps track of that. So it changes the intrinsic value estimates of stock prices, the target prices of it. It makes specific research-orientated suggestions on which strikes to do, and it follows the trade.

It tracks them, making it so easy where the subscriber just can log into their brokerage account and place the trades themselves. Or if they have a broker or advisor, they can place it themselves too. Once again, not acting as an advisor in this capacity.

So pretty simple there.

[Tobias] So one of the nice things about that is that whatever the stock price does in between, you can generate a slightly better return than the underlying stock price, but it requires you to make sure you’re putting on the right positions. And that’s one of the things that the value options letter helps with.

[Tim] And look, I mean, there’s times where you’ll get called away on a stock that you wish you would have just held. And so sometimes the right thing is you own a thousand shares of maybe you sell covered calls on half. Sometimes that’s the right thing to do.

So there’s a lot of different nuance there, but you’re absolutely right. It’s a huge tactic that you can utilise. And statistically, there’s a lot of data on options.

So Buffett, he did the Burlington Northern Santa Fe. He did the Coca-Cola. He sold index put options during the financial crisis because the markets got so cheap that, look, that’s when he was comfortable doing that.

And just a reminder that Toby and I have talked about before, during the financial crisis, because we had now endured two 50% bear markets, that buy and hold was seen as debt. People did not want to do buy and hold for probably up until 2015, 2016. Once the market really had quite a few good years behind it.

And so we’ll get other timeframes where the market is not performing exceptionally well like it has the last few years, where doing these types of strategies can both protect your portfolio and also help you generate good returns during flat markets. So that’s a big benefit of it. So there’s a lot of evidence there.

We have a lot of the studies on our website that you can look at. I’ll leave that to it. So let’s go start with some specific examples.

And one important note here is that all of these trades were on the value options letter website. So they were current as of the time that we recorded this. And what’s cool about the website is that it tracks the trades.

And so let’s say we get exercised on a position and we end up having to sell calls. It tracks that kind of stuff. But to see the current standing of it or anything like that or new trades, you’ve got to subscribe to the site.

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

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.

[Tim] Exactly. And the comparison is what Buffett did with Burlington Northern and Coca-Cola when he was willing to own those stocks at that price. So the risk is you got to be right on stock selection, right?

So you still have to be right. I mean, if you do these strategies on a stock that goes to zero, you’re still going to lose a lot of money, of course. But these are stocks you want to own anyways.

That’s the key differentiator here. That’s why they’re value options. Value options, Toby.

And the other thing is that what I like is that if you get exercised, if this stock expires below 60, that’s just the beginning of the game. In the example I gave before of why I got into this business, why I got into this concept, where I saw that people that were doing iron condors and stuff like that, they were taking permanent losses of capital. And so the cool thing with this is you get exercised, this stock could double from there potentially, or you could do the wheel and keep selling covered calls against it.

So there’s so many ways to skin a cat with these strategies. And that’s why I like the value options letter so much is that now the technology is so good that it’s able to track them and make continued research strategic recommendations on that.

[Tobias] You can take advantage of the high volatility in these stocks rather than- Precisely.

[Tim] …

[Tobias] being taken advantage of in the market.

[Tim] That’s what attracted me. Exactly. I mean, I saw software is just getting killed.

Let’s look at some of the names that are really high quality that are not going to be decimated by AI and that offer value. And then exactly, when volatility is high on these names, you get really attractive premiums. So great risk reward.

Selling Put Options on Undervalued Stocks: Fiserv and Alexandria Real Estate

Let’s go ahead. Fiserv. So this is one of the three major US payments and financial tech platforms.

And they acquired First Data in 2019. And their primary franchise is that Clover point of sale. So I know my favourite restaurant in Scottsdale, it’s a kebab place.

They have Clover and it’s the annoying things where they ask for a tip for every single thing in the world. But it’s great for these small business owners and for medium-sized business owners, because it integrates everything. There’s all these software attachments related to it.

I mean, the ease of sale versus them trying to swipe your card over and over again. It’s so much easier.

[Tobias] They’re in Australia too. I’ve seen FiveServe- Oh, they’re huge. …

points of sale in Australia.

[Tim] They’re global. They’re global, Toby. They’re a global massive franchise.

And this was another, it was a total glamour stock. The 52-week high was 192. And it was one of those, Toby, that you probably remember, it was known as like a compounder.

And remember like the compounder row theme, where it’s like, you just buy these compounders at whatever price and they keep compounding. That’s what FiveServe was until the rug got pulled. And it was later last year, they reported earnings and the earnings were disappointing, but the guidance was worse.

They realised that what they were doing was not the right service experience for some of their customers. They had some dissatisfaction there and they realised that they were going to have to reinvest in their processes and the product a little bit and the service to make it better. So it’s a fixable problem, but the stock just got devastated.

That’s the key, right?

[Tobias] It’s still a good business, but handicapped at this price, this is where it makes sense.

[Tim] All these businesses that we’re talking about, Toby, are profitable. They cash flow well, free cash flow well. They’ve got good balance sheets.

We’re not talking about companies that are on their last breath, the cigar butts investments. We’re not talking about those. So you can see the metrics, 9.7 times trailing earnings. And they feel that they can grow earnings per share by 10% plus over the long term. It’s going to be slower this year. A lot of times you’ll see that.

Short-term headwinds are the reason why the stocks are cheap, why there’s a lot of volatility, but the long-term prognosis is very attractive. So what we did was the value options letter sold a put on FiveServe at $50. And it collected $4.50 a share of a premium. You can kind of refer to it as a leap where it expires in January 15. So 254 days. Normally my definition of a leap is over a year, but this meets most people.

So 254 days. What’s the return dynamics? If the stock’s above 50 at expiration, keep in mind the 52-week low is 53 roughly.

52-week high is 191. If it’s above 50, you just made 9.9% on your maximum risk, which is 14.2% annualised. Your worst case scenario is you own this stock at a single digit earnings multiple, a breakeven of 45.50. And you’ve got all the upside or downside associated with it from there. So we really like the risk reward of this strategy on a name like this. And once again, the idea of the letter is to give you options that you don’t have to do every trade. If you really don’t like a company for whatever reason, you don’t have to do that.

The letter is going to put out on average three recommendations per week. When markets are attractive, it might be a little more. When markets are highly unattractive, it might be a little less.

But on average, that’s kind of the goal, three to five. So just a fantastic value on that end. But you don’t have to do every trade.

And it takes additional consideration. You don’t want too much exposure to any one name or industry, of course, but that’s between you and your financial advisor. We’re not acting in a financial advisor capacity.

All right, last one that we’re going to talk about today. This is a hated name, hated name. And it’s had a really rough go of it.

So Alexander Realty, they own a lot of the labs, they own the top quality labs in the country and adjacent office space. And they have a mega campus strategy. So, you know, where most of the biotech industry is, is Cambridge, San Fran, San Diego, the Research Triangle.

And a lot of those, you know, the companies go where the people are and vice versa. And so their idea is they have these wonderful properties and they cluster it. And it’s been a great business overall, especially, you know, going into and after COVID, there was tremendous growth, rents kept going up, but there became a supply, a supply imbalance, too much supply was put into the market.

And while that supply was kind of being worked out, then kind of the administration changed. And, you know, there was all the upheaval in the FDA and the CDC and NIH. And so a lot of the biotech companies have been much more reluctant to expand and grow.

And so that’s hurt this company because their occupancy rates have been going down. The leasing rates have been going down. They’re still working on the oversupply.

And what’s funny is this was a REIT that was, that had probably arguably the best balance sheet in the industry, at least one of the top ones, investment grade balance sheet, still has investment grade, very long debt maturities, which is great in a, in a higher rate environment. So they’re not having to refi it at higher rates as much as their peers. But so anyways, let’s get to the trade.

We don’t want to focus, you don’t have to focus too much on any one stock. It’s the strategy and it’s the general principles. You’re building a portfolio, of course.

But what we did at the value options letter is we sold a $40 put that expires in October 16th. So this is 165 days out. And on that put, collected $4 and 55 cents a share.

So $455 of total credit. And the breakeven is $35 and 45 cents. This stock, the 52 week lows, 3941, the 52 week highs, 8824.

A few years ago, this was well over 200 bucks. So that is a 12.8% return in 165 days, 28.4% annualised. And this is a stock that historically it traded at 18 to 24 times FFO.

It’s trading at about 6.3 times that right now of their normalised FFO. So funds from operations, it’s kind of like the equivalent of earnings for REITs. Because you’ve got depreciation and stuff like that.

So earnings for REITs are really not very helpful. So think of FFO, price to FFO is kind of like price to earnings metrics. So look, really, really cheap stock.

But another tactic that you can use to generate attractive returns with less risk than just owning the stock outright. So investment grade company, once again, we’re not talking about companies that are on the verge of bankruptcy. We’re not talking about companies that aren’t profitable.

We’re willing to own these stocks at the discounted price. And that’s really what separates the value options letter from a lot of these other options, subscriptions out there, or value options, as you said, Toby.

How to Evaluate Options Trades: Risk, Return and Capital Protection

[Tobias] Right. They’re not speculative positions. We’re trying to find positions that have a good risk reward, good handicapping, and you can see what your expected return is and also where you’re likely, if the stock gets put to where you buy it, and if you’re happy to own it at that price, then that’s a good trade for you.

[Tim] Yes, sir. Yeah, I agree completely. And so what do subscribers get?

So you’re going to get on average three to five new trade ideas each week. So you’ll see the full thesis. You’ll see the strike prices.

You’ll see the capital at risk. It’s in a really beautiful user-friendly format. It’s for you to make the decisions on which ones you actually want to do.

We have a lot of educational content that can help you understand how to place the trades with your brokers, but you just go on your Schwab, your Fidelity and place them accordingly. Or you could call your advisor who probably doesn’t know how to do a lot of these things, honestly. So that would be another option.

It’s going to have exit analysis on every trade, what worked, what didn’t, help diagnose. If you get exercised, look, do we sell calls? What strike prices do we sell at?

So very powerful features there.

[Tobias] And also if the trade has moved in your direction, but there’s some time left, maybe now’s a good time to exit. So you increase your IRR without having to wait for the last little part of the trade to complete.

[Tim] Correct. And what’s cool about the website is it aggregates the track record, which you’ll see over time. So it’s not cherry picked.

You’re going to see closed trades. And so you’ll see the aggregate win rate, the annualised return and all that. That’ll be done over the time.

And the measure of that is over a long period, right? It’s not over a month or a year. As you see, some of these trades are over a year, but over the long term, how does it do?

And then you’ll see the research on the underlying businesses. Both Toby and myself are very research orientated people. We like knowing the businesses and understanding what makes them work, looking at the valuation metrics of it.

I mean, Toby’s literally the guy that wrote a book, deep value, and they acquires multiple, you know, and those are very inspirational to me and they’re right in line with my logic. And so that’s, we’re going to pass that on to you. And then also real time alerts via email, push and discord.

So you’ll see it when a trade’s recommended by the newsletter, you’ll get an email, a notification. And if you want to, you can place it with your brokerage then and there. So tremendous, tremendous value.

And what’s great is the price is, it’s only 200 bucks a month or $2,400 a year. That’s the price that it’s going for. So, you know, the question you got to ask yourself is, am I going to get that much value?

But even better, because it’s a new service and because Toby and I are so excited about this, we really look at subscribers as being, you know, partners in this, because they’re showing the trust and giving us the opportunity to provide the value for you. And we take that trust very seriously. And so we’re offering a discount where it’s just $99 a month or $999 for the full year.

And so that’s going to last for just the founding subscribers for a short amount of time. It will not be long, but we want to be able to, you know, show the quality of the product, grow it, grow the service, grow the Discord chats. It’s going to be ultimately a membership site where people can interact and do that.

Once again, not advice, not a financial advisor in any capacity with this site, but Toby, anything you want to add on that?

[Tobias] Just that we think that there’s a really good chance that you’ll be able to earn back the subscription fee quickly. And that’s our objective to make this something that generates income beyond the subscription price for you.

[Tim] Agreed, agreed. And so here’s the important disclosures. There’s risk in all investing.

Options are not suitable for all investors. It involves risk. Past performance does not guarantee future results.

It’s a publication, not advice. We will disclose when we have positions. Almost always, we or firms will own some of these, at least myself.

And forward-looking statements cannot be relied on with certainty. So that concludes really this presentation, Toby. Thanks for going over it with me and from both of us.

Look, we’re excited to have you as part of this journey. This is a product that I’ve wanted to put out for 20 years. And it’s finally become a tangible reality.

And the goal is to help do-it-yourself investors, make it easier for you. I don’t want you to try doing strategies you don’t know how to do or invest in securities that you don’t know why you own them and stuff like that. The goal of the Value Options Letter is to kind of fix those problems.

And we hope that you enjoy it.