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Jul 16 2011 / Strategy Article /

Johnson and Johnson Stock - Rolling Put Options

 
 

Johnson and Johnson Stock - Put Options

Johnson and Johnson Stock - Trade Introduction

With July 2011 options expiry, my Johnson and Johnson Stock $65 put options expired. This trade commenced back in April 2010 and demonstrates the value of consistency in sticking with a plan on a quality company.

This put selling investment in Johnson and Johnson Stock started in April 2010 when I sold 5 Puts For May at the $65 strike for $1.25. Within just a couple of weeks the stock fell until into December when it almost made a come back only to fall again

Below is the chart for Johnson and Johnson stock for the April 2010 to July 2011 period. You can see that Johnson and Johnson stock has been in a range between lows around $58.60 to the present high of $67.74. over the 17 month period. During that period the puts I sold got deeper and deeper in the money, yet I was never assigned and continued earning premium. Now 17 months later Johnson and Johnson stock has recovered beyond $65.00, releasing my puts from the possibility of assignment and allowing me to continue selling puts on JNJ stock.

Johnson and Johnson Stock - April 2010 - July 2011

How To Avoid Early Assignment:

Selling puts that become deep in the money have a somewhat simple formula to avoid early assignment. It does not always work, but on Johnson and Johnson stock the formula works pretty well because the stock is fairly predictable in relation to, maybe commodity stocks. It's because of volatility. Commodity stocks have a lot more volatility than stocks like Johnson and Johnson stock. And it is not alone. Other similar stocks include PepsiCo Stock, Coca Cola Stock, Microsoft Stock, Intel Stock, Clorox Stock and many more.

For example, below is a 10 year stock history chart of Johnson and Johnson stock. You can see there is a distinct pattern over the last 10 years. For traders this range would be easily traded. For investors like myself who sell put options this gives a great deal of comfort when picking strikes. While the $65 is on the high side for selling puts, I can see that Johnson and Johnson stock has returned to $65 numerous times over the 10 year period. Therefore for selling the $65 put, I have confidence that at some point in time Johnson and Johnson stock we revisit the $65 level and probably leave my sold puts out of the money.

Johnson and Johnson Stock - 10 stock history year chart

Below is the 10 year stock history chart for Microsoft Corporation Stock. Again, the trend is obvious as the stock has been caught between $22.00 and $28.00 various times throughout the past 10 years. Therefore just like in Johnson and Johnson stock, when I sell Microsoft Stock puts I have confidence that my puts will eventually end up out of the money. Therefore I can keep rolling the puts and earn income while waiting for the stock to recover.

Microsoft Stock - 10 Year Stock History Chart

The above companies have developed almost a defined tradeable range. But many stocks do not, in particular commodity stocks. Below is the 10 years stock history chart for Pan American Silver Corp Stock. This would be a very difficult stock to sell puts against for any long term period.

Pan American Silver Corp 10 Year Stock History

You can readily see that many stocks would not lend themselves to long term selling of puts. Below is another example, the 5 year stock history chart for Potash Corporation of Saskatchewan.  Again this would be a difficult stock to sell long term puts against.

Potash Corp 5 year stock history chart

When selling long term puts it is important to keep an eye on the put premiums as the option month sold get closer. For example with Johnson and Johnson stock, when I was holding April $65 puts and Johnson and Johnson stock fell to $58.60 by March 18 2011, the April $65 puts were trading for $6.50. That means the puts only had 10 cents of premium left in them.

Example:  March 18 2011 - Johnson and Johnson stock at $58.60 - $65 put at 6.50 =  $65 less 6.50 = $58.50.  Only 10 cents of premium in the put.

This means it is time to buy and close the March $65 puts and roll further out unless I want to be assigned early on the shares. Even if by rolling out the premium I earn is not that large, the only way to avoid assignment is to close and move further out. I have had positions that when closed and rolled out four to six months only earned 30 cents of premium. While it seems perhaps pointless to earn just 30 cents for 4 or 6 months, remember that stocks move around a lot and often the stock will move higher and allow me to buy back those puts that I sold for just 30 cents and earn double or triple that much by moving out another 4 or 6 months.

WATCHING THE PUT PREMIUM IN RELATION TO THE STOCK VALUE IS THE MOST IMPORTANT ASPECT OF KNOWING WHEN TO ROLL PUT OPTIONS THAT ARE DEEP IN THE MONEY.

Many investors fail to understand how selling options can be beneficial. In fact, many investors consider options not investment strategies at all which is a shame, because as you can see in the table below which follows Johnson and Johnson stock for 17 months, selling put options can be a very successful investing strategy.

JOHNSON AND JOHNSON STOCK - TRADE HISTORY TABLE

This trade commenced in April when I sold 5 put contracts for May 2010 at the $65 strike. From there it became a series of rolls in order to garner income and all the while stay ahead of any assignment as Johnson and Johnson stock fell. For more than a year I rolled the puts forward until July 15 2011, when with Options Expiry, the July $65 strikes were out of the money as Johnson and Johnson stock closed at $67.45 and the put options expired without assignment.

Let's look back at the trade to see how it is very viable to be in certain stock for long periods of time through rolling put options forward, all the while earning more and more income.

Johnson and Johnson stock has fallen over the past few months. I have no choice but to close now as at $3.10 there is only .05 cents of premium left. Remember - I do not want to be assigned shares yet. I wish to continue to roll them and earn more income. Johnson and Johnson stock hadn't done much for over a month and with it this low it was time to roll it again as there was just 15 cents premium in the put.
DATE STOCK
PRICE
ACTION (all prices shown include commissions paid) GAIN/LOSS TOTAL INCOME
April 17 2010 65.02 Sold 5 Put Contracts May $65 at $1.25 611.75 611.75
April 27 2010 64.80 Bought to close 5 Put Contracts May $65 at .90 (463.25) 148.50
April 27 2010 64.80 Sold 5 Put Contracts June $65 at 1.87 921.75 1070.25
APRIL 27 2010 - SO WHY ROLL THE PUTS WITH SO MUCH PREMIUM STILL IN THE MAY PUTS? - Good question!
Here is my chart from when I was following JNJ Stock. Have you ever had a stock you are selling puts on, fall? The premium changes as the stock falls and eventually the premium to BUY TO CLOSE the sold puts is almost the same as the next month out when I go to roll my put options forward. The chart shows the stock is perhaps beginning to fall after making a recent high. 

Johnson and Johnson Stock Chart - April 2010

My whole goal of selling puts is to earn income to eventually own Johnson and Johnson stock but paying for part of them with other people's money. By rolling now I can earn a considerable return for June and still have a gain from April 17, which was just a few sessions ago. If the stock falls I will probably end up rolling further out and earning less then rolling the puts now. The best premiums are always in the closest month. By rolling now I can roll out to just 1 more month, leaving the future months still open should the stock fall further quickly. 

June 18 20100 59.18 Expiry: Bought to Close 5 Puts JUN 65 at $5.91 (2968.25) (1898.00)
June 18 2010 59.18 Sold 3 Puts Oct $65 at $6.60 1969.25 71.25
June 18 2010 59.18 Sold 2 Puts Jan $65 at $7.70 1530.50 1601.75
June 18 2010 - Deep In The Money Puts Now
ALSO ALWAYS REMEMBER THAT BY ROLLING OUT JUST 1 MONTH WITH THE STOCK THIS LOW, THE CHANCE OF BEING ASSIGNED SHARES EARLY IS VERY HIGH. To avoid this I always make sure there is premium in my put. If there is no premium then I buy and close immediately and roll further out.

Selling puts to earn capital in order to eventually own shares but with other people's money requires a bit of different thinking when it comes to selling puts. I am not as concerned about earning big gains each month as often I need to roll out so far that if calculated monthly, the return is not that high. But this is a long term trade and I might be rolling these puts for more than one, two or three years before finally being assigned shares. I have had some trades where I rolled puts for 7 to 10 years. The whole strategy is to keep earning capital. If that means I have to roll further out with less earnings than I would like, but it avoids assignment, then so be it. Remember the goal is to use as much of other's peoples' money as possible, to pay for my Johnson and Johnson stock. I can't do that if I am assigned early.

Therefore on June 18, I split my 5 naked puts into two lots. I placed 3 puts into October with low premium earned, but only 4 months away which gives me an opportunity for Johnson and Johnson stock to recover and roll again before January. I then sold 2 puts into January 2011 which generated much better premiums.

So by June 18 2010 I had earned $1601.75 or 4.9%.

Oct 11 2010 63.23 Bought to close 3 Puts Oct $65 at $1.83
This is excellent as the stock had recovered a lot of ground and by closing early the premium cost to close was negligible, but as explained earlier, the roll out to April earned excellent premiums.
(559.75)) 1042.00
Oct 11 2010 63.23 Sold 3 Puts April $65 at $4.55
I already had 2 Puts Sold for January 2011 at $65.00. By rolling further out to April this gives the stock another 6 months to try to recover higher. Since I still have January puts I will have an opportunity to roll those puts for more income as well.
1354.255 2396.25
Dec 31 2010 61.85 (629.50)) 1766.75
Dec 31 2010 61.85 Sold 2 puts February $65 at $3.55
Now there is enough premium that I can roll just 1 month out. Recalling my earlier comment, This allows me to earn better premiums as the closest month always has the highest option premium.
700.500 2467.25
Feb 18 2011 61.00 (839.50) 1627.75
Feb 22 2011 60.90 Sold 2 puts July $65 at $4.95
With the stock so low, and the VIX (Volatility index) also very low since the market is moving higher, I had to go all the way out to July just to earn some premium and avoid being assigned shares.
980.50 2608.25
Mar 18 2011 58.60 Bought to close 3 puts April $65 at $6.50
Johnson and Johnson stock continued to fall and the premium in the puts was just 10 cents. It was time to roll these puts again. I had decided to again split the puts
(1960.75) 647.50
Mar 18 2011 58.25 Sold 2 puts Jan $65 at $9.05
I had now sold just 2 puts and the loss was $160.75 to drop 1 put. This freed up $6500 in capital being held to assist purchasing the puts. I then sold 1 additional put but further down in price. I had to adjust this trade a bit from the Johnson and Johnson stock 2011 actual trades as I did 2 puts rather than 1 put. In order to keep this trade accurate for the sake of this article I will show just 1 put sold. (In my actual trade I did 2 puts as I have a lot of confidence in Johnson and Johnson stock)
1800.50 2448.00
Apr 15 2011 60.56 Sold 1 put October $62.50 at $4.15
I am now still holding 5 puts, but only 4 are now at $65.00. To move 1 put lower cost me $160.75. But now I have 1 put at $62.50 and 4 at $65.00. By going out to October which is 6 months) with this put I have earned far more than the $160.75
Here is the breakdown of the puts being held:
2 Puts for July $65
2 Puts for Jan $65
1 Put for Oct $62.50
406.75 2854.75
Jul 15 2011 67.45 Options Expiry for July - 2 Puts for July $65 expired out of the money.
Now holding
2 Puts for Jan $65
1 Put for Oct $62.50
Return on capital invested at this point:  $2854.75 / $32250.00 (400 shares at $65.00 and 100 shares at $62.50) 8.8%.
   
Jul 15 2011 67.45 interest earned in high interest savings account since April 17 2010 - Total Capital set aside to cover sold puts - $31,250 480.25 3335.00
At this point with the stock at $67.45 and the stock market possibly ready for a pullback, I could either sell further out in time these 2 puts and at a much lower strike. For example the October $62.50 is at .90 cents. I could also consider going out to January and sell the Jan $60.00 at $1.36 or the $57.50 at $1.00.
Since I am already holding 2 puts for Jan $65 and 1 put for Oct $62.50, I would probably consider the January $60 at $1.36.
If assigned on all the shares at these strikes my total cost for the trade is $31,250.00 less earned capital - $2854.75 + Jan $60 puts for $262.50 put premium earned + interest earned- $480.25 = $27652.50 / 500 shares = $55.31. The present annual dividend is 2.28 which provides a yield of 4.1%.
Not bad for just a year and half of work. If I was willing to take the shares I know that my own capital in the stock is just $27652.50 and I am earning 4.1% a year on that capital or $1140.00 a year with the chance of annual dividend increases.

Johnson and Johnson Stock - Trade Summary

There are a couple of things to consider when reviewing this trade. I kept selling the $65 strike despite the stock falling more than 10% below that strike. During this time period it was very possible to reduce the number of puts at that strike and sell some puts at lower strikes which still could generate a credit. This meant that I am basically averaging lower into the stock.

Therefore selling puts is not necessarily a case of pick a strike and then be stuck at that strike. When an investor considers the strategy of selling puts long term on a stock they wish to own, it is obvious that they can continue to generate income and reduce their overall cost basis in the stock. It is a matter of avoiding assignment by staying ahead of the stock movement through watching put option premium to know when the premium is low, increasing the chance of early assignment. At that point roll the puts further out in time while still earning income. As well with stock price fluctuations it is possible to split up the put contracts and roll some lower, all the while working yourself lower into the stock and still earning income.

There is a lot to like when it comes to selling puts on Johnson and Johnson Stock.

 
 

 
 

Disclaimer: There are considerable risks involved in all investment strategies. Trade at your own risk.
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