The long-awaited Christmas rally is here, taking the S&P 500 less than 5% away from its all-time highs. While the market could certainly climb higher from here (especially with fund flows chasing performance into year-end), I have been having a hard time hitting the “buy” button with most stocks not offering a great margin of safety.
I’ve been forced to put on my thinking / creative hat, and look into certain situations where I can generate attractive risk-adjusted returns that are somewhat less correlated with the market.
Some of these are candidates for adding to the Hidden Rock Capital Model Portfolio, and some are ones I am just investigating with a tracking position in my personal portfolio (since it’s not compelling enough for HRC Model Portfolio).
These out-of-the-box ideas include:
Covered put offering a ~15% yield over the next month with limited downside
Liquidation special situation paying out a 30%+ dividend yield and more payouts on the way (HRC Portfolio holding)
Let’s dive in!
Spirit Airlines covered puts
I have dabbled with selling cash covered puts in the past to mostly good effect, and am seeing a nice opportunity in selling Spirit Airlines (SAVE) near-dated puts.
For those unfamiliar with selling cash covered puts, you are essentially taking on the obligation to buy a specific stock at a certain price if it falls below that price by the end of the expiration period. In exchange, you received cash upfront (“premium”). The cash covered part of the put means that you are locking up the cash needed to purchase the stock as collateral.
Using the aforementioned Spirit Airlines puts as an example, I have sold $10 strike puts expiring on 1/19/24, receiving around $1.50 in premium. Since each put contract covers 100 shares, and the contract I have sold is cash secured, this means:
I have locked up $1000 in cash per put contract ($10/share strike price x 100 shares)
I have also received $150 in cash up front to invest as I wish ($1.50/share premium x 100 shares)
You can think of this as a 15% monthly yield you receive for taking on the risk of having to buy SAVE stock at $10/share, which comes out to a 435% annualized yield…clearly you are generously compensated for taking on this risk!
Two different scenarios will materialize on the put expiration date of 1/19/24, depending on the stock price of SAVE on that day.
If SAVE stock price is $10/share or higher, then the put will expire worthless, and I will gain back the original $1000 cash locked away as collateral plus the $150 in cash premium. So my $1000 investment has turned into $1,150, which is a 15% monthly return (435% annualized return)
If SAVE stock is less than $10/share or higher, then I will be obligated to purchase the stock for $10/share. This means my loss per share would be the $10 strike price minus the current stock price and minus the premium I originally received. Let’s say SAVE stock is trading for $8/share at expiration, then my loss would be $50 calculated as the following: ($10/share - $8/share - $1.50/share) x 100 shares
Currently, SAVE stock trades around $16/share, so it would have to fall almost 40% to reach the $10 strike price. So why is the market willing to offer such a fat premium (15% monthly yield) on these puts?
The reason of course is that SAVE’s pending acquisition by Jet Blue is being contested by the Department of Justice (DOJ), and there is a material likelihood of the merger being broken up.
I personally believe the merger will likely go through given the size of the two airlines merging and Jet Blue’s commitment to divesting certain airport terminals to increase competition. But nevertheless this is a binary situation where the merger may be broken up, which would cause SAVE’s stock price to fall significantly.
Let’s assume we do not have any special legal insight into the DOJ decision, and it’s a 50/50 coin flip on whether the merger if approved or not.
If the merger is blocked, then I believe SAVE should be valued between $5 and $10/share as a stand-alone entity based on my analysis on trading comps. The stock price history supports this view, as the stock price temporarily broke to around $8/share last month when the DOJ trial seemed to be going unfavorably, but quickly rebounded into double digits as the market realized it was over-reacting to the downside.
Let’s take the pessimistic end of my stand-alone estimate for SAVE around $5/share - this is where the stock price may fall if the merger is blocked. Given the upfront premium of $1.50/share, the loss would be $3.50/share on the original $10/share investment…not great, but also with limited downside.
If on the other hand the merger is eventually approved, the takeout price of $30+/share would mean these puts would expire worthless and I can keep the $1.50/share premium.
The third scenario is that the trials continue without any definitive conclusion by the expiry date of 1/19/24, in which case we can expect the stock price to hover near its current range around $15-$16/share and have the puts expire worthless.
So in conclusion, I see an opportunity selling SAVE cash secured puts where I can earn a juicy premium on my cash in an otherwise fully valued market, with material but certainly limited downside risk in a bear case scenario (merger being blocked).
For those looking for a more straight-forward way to generate a nice yield, let’s look at idea #2 which is a liquidation situation that is a HRC Model Portfolio holding (therefore open for subscribers only):