In my last article, I discussed shorting a put option as a useful investment strategy for value investors. In theory, shorting a put option allows investors to “buy” stocks cheaper than the current market price. Recently I had a chance to short a put option; I decided to share my personal experience to show whether such strategy works in real life.
- May 25, 2017 – Shorted a put option
I sold 1 put option of Michael Kors (KORS) stock at $1 with a strike price of $35 and an expiration date of June 16, 2017. The stock price was $36.63 on that day. Since each option contract is associated with 100 shares, I collected $100 at the time of sale. There were 2 possible results at the time of option expiration:
(1) The stock price remains above $35 and the option expires: I get to keep $100
(2) The stock price drops below $35: I am forced to buy 100 Michael Kors stock at $35 per share.
In other words, it was equivalent to buying Michael Kors stocks at $34 per share when the actual stock price was $36.63.
- May 31, 2017 – Q1 Earnings release
On May 31, Michael Kors released its earnings result. Even though the company’s earnings beat the consensus, its FY18 guidance was below the market’s estimate. Here is the example of the headline I saw on that day…yikes.
Even though the stock price dropped to $33.18, which was well below the strike price ($35) of the put option, the option was not exercised by its holder.
- ·June 16, 2017 – Option Expiration Date
At market closing on June 16, the stock price was $34.60, which was lower than the strike price of $35. The put option was exercised and I was forced to buy 100 Michael Kors stock at $35. My unrealized gain at this point was $60 [$1 x 100 – ($35 - $34.60) x 100] after risking $3400. In terms of % return, I made about 1.76% gain in 3 weeks (from May 25, 2017 – June 16, 2017) which translates to the annualized return about 35.42%. Not a terrible return, however, I decided to hold the stock hoping for a better return.
Shorting Michael Kors’ put option was the perfect example of shorting a put option as an investment strategy. If I had bought the stock outright on May 25, 2017, my purchase price would have been $36.63 and I would still be at a loss at the current price of $36.55 (as of July 30, 2017). Shorting the put option and purchasing the stock at the hypothetical price of $34 resulted in a gain of 7.5% instead. While there is a considerable risk in shorting put options, I would recommend value investors to try it at least once. You cannot beat the market if you are doing the same thing as everyone else.