- 1 I recently disclosed that I have initiated a position in Stryker Corporation (SYK). I have a long-term positive outlook on the company but am not ruling out the potential for a broad market pullback which would likely result in a drop in SYK's share price.
- 2 In this brief article I explain the option trade I have placed, which has generated option income, and what are the potential outcomes of the trade.
In this brief article I explain the option trade I have placed, which has generated option income, and what are the potential outcomes of the trade.
- I have a positive long-term outlook on Stryker and recently initiated a position at just under $200/share.
- The market appears to be ripe for a broad market pullback and investors would be wise to consider a ~25% pullback in SYK’s share price as not being out of the realm of possibility.
- The option trade described in this article entails more risk than the option trades I have previously placed.
In my November 10th Stryker Corporation (SYK) article I indicated I would be acquiring shares for one of our daughter’s investment accounts. I, however, actually acquired SYK shares for one of her investment accounts AND I also acquired shares for one of my investment accounts. I do not publicly disclose details for either account but will disclose the purchase price was under $200/share.
SYK’s share price has subsequently trended upwards. I am, however, of the opinion the odds favor a broad market pullback within the next 6 - 12 months and SYK’s share price will most likely get caught in the downdraft.
The more I analyze SYK’s long-term potential the more comfortable I become with my recent decision to initiate a position for the very long-term. I intend to acquire additional SYK shares over time but based on a recent conversation with a fellow investor whose opinions I highly regard, I have decided to initiate an option trade.
The option trade I describe below entails a bit more risk than option trades I have presented in previous articles, and therefore, I urge caution if you decide to enter a similar trade.
Given that I was sufficiently comfortable to acquire SYK shares at just under $200, it stands to reason that I would be happy to acquire additional shares at ~$158. So…I wrote ‘naked’ $165 Puts with a January 2021 expiry.
Through this option trade I am allowing another investor to sell me shares at a $165/share up until January 15, 2021. In exchange, I have received $7.60/share; each option contract represents 100 shares so I received $760 for every contract I wrote (less nominal commission).
If SYK is trading above $165, no investor in their right mind is going to sell me their shares for $165. I essentially retain the option premium I collected and receive no shares come expiry.
Now, let’s use a worst case scenario where SYK’s share price plunges to $0. I think this probability is extremely remote but want to demonstrate the worst that could possibly go wrong with this trade.
If the buyer of the option contracts exercises their right to sell me SYK shares at $165, I would need to come up with $16,500/contract but I would receive worthless shares in exchange. Remember, however, that I have received $7.60/share (before nominal commission) so my true maximum loss would be $157.40/share ($165 - $7.60) or $15,740/contract.
I really don’t think the worst case scenario will materialize but it is possible SYK shares, which are currently trading at $206.25, could pull back 20% to ~$165. Nothing should be ruled out.
Let’s suppose shares are trading at $140 come expiry. The option buyer would have the right to sell SYK shares to me at $165 meaning I am ‘underwater’ $25/share or $2,500/option contract. I, however, collected an option premium of $7.60/share so I am ‘underwater’ $17.40/share or $1,740/contract.
My plan is to hold SYK shares for the very long-term and fully expect that in several years the value of each share will be worth more than the current market value.
Sure, I don’t collect the quarterly dividend but I am not investing in SYK for the purpose of generating dividend income. I am investing in SYK for the long-term growth potential.
I know some readers may not be comfortable with the risk associated with the option trade presented. In fact, this is an option trade which requires an account to be authorized for ‘riskier’ option trades; the level of risk differs dramatically from that of ‘covered calls’, for example. I, however, feel comfortable with the risk I am taking on.
The way I look at it, I like SYK’s long-term outlook and was comfortable in acquiring shares at under just $200. It, therefore, stands to reason I am prepared to acquire shares at a lower price….assuming the share price decline is not because of some permanent impairment to the business but is rather because Mr. Market has decided to assign a different value to the company.
I certainly do not think there is any likelihood that SYK’s share price will plunge to $0. At the same time, I am not ruling out the possibility that it could retrace at least 20% between now and January 15, 2021. Based on the information at hand, if SYK’s share price were to plunge ~20% (or even more) I would not be concerned.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long SYK.