option_example - Morningstar.com Another Look at a...

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Morningstar.com Another Look at a Wide-Moat Put-Writing Opportunity Wednesday April 23, 7:00 am ET By Philip Guziec At Morningstar, we are currently developing a methodology that can be used to combine fundamental research with options investing. One strategy that we think can be used relatively safely is writing put options on wide-moat companies with low or medium fair value uncertainty ratings. In other words, we wish to write put options on companies that, in our opinion, have durable competitive advantages whose fair values lie within a tightly bounded range. Using this strategy, we can generate annualized double-digit returns if the options expire worthless. Or in case the stock gets put to us, we'd end up owning stakes in wonderful businesses at attractive prices--we think it's a win-win situation. The only real risk here is a change in the intrinsic value of the stock (or that our fair value estimate is too high). We try to mitigate this risk by choosing only high-quality companies whose fair values can be assessed with a fair degree of confidence. However, if news comes out that changes our opinion of the stock, and the share price drops as well, we're exposed to a real loss. Still, even in that scenario, we perform better than we would have if we purchased the shares outright today, because we earned the option premium. We'll illustrate this strategy using eBay (NasdaqGS: EBAY - News ) as an example. We believe that eBay is a wide-moat, medium-uncertainty company, exactly the kind of long-term investment we look for when it trades at a sizable discount to its intrinsic value. However, Mr. Market differs not only in his opinion of eBay's value, but also of its risk. He thinks it's a high-risk stock because the share price moves around a lot. But we think it not only has a wide moat, its fair value can be bound within a tight enough range to fall within our medium fair value uncertainty band. In short, we think Mr. Market is way off on eBay, in more ways than one, and options can be a reduced-risk way to
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option_example - Morningstar.com Another Look at a...

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