Case Study: Finding a Stock for Puts

Selling puts requires a specific mindset: you're committing to buy shares if assigned. That means the stock selection process is even more critical than for covered calls. You're not just holding a position, you're potentially building one at a lower price. This case study walks through finding a company suitable for cash-secured puts, from initial screen through final trade execution.

TL;DR

• Screen for quality first: Put selling means potential ownership, so only consider businesses you'd happily hold
• Calculate intrinsic value: Your put strike should be below fair value, creating margin of safety on assignment
• Check premiums versus risk: Ensure the premium adequately compensates for the capital at risk
• Verify no earnings window: Avoid binary events that can gap stocks through your strike
• Use Wall St Yardie to determine fair value before selecting strike prices

The Put Selling Mindset

Covered calls start with shares you already own. Puts start with a commitment you're willing to make. When you sell a put, you're saying: "I'd buy this stock at this price, and I'm willing to be paid while I wait."

That commitment changes the selection criteria. You're not looking for stocks with good options liquidity first. You're looking for wonderful businesses trading above prices you'd love to pay. The put premium is a bonus, not the goal.

The ideal put selling candidate has:

• Outstanding business quality: Durable competitive advantages, consistent earnings, strong management
• Undervaluation or fair value: Trading near intrinsic value or ideally above it temporarily
• Put strike below intrinsic value: Your commitment price provides margin of safety
• Adequate premium: The income justifies the capital set aside
• Clear event calendar: No earnings surprises waiting to ambush you

Let's find one.

Step 1: Screen for Business Quality

For puts, we emphasize quality over value in the initial screen. We want companies worth owning first. Valuation comes later when we set strike prices.

Quality filters (using Finviz):

• Market cap > $20 billion (large, stable businesses)
• EPS growth past 5 years > 8% (compounding earnings)
• EPS positive every quarter last 2 years (consistent profitability)
• ROE > 15% (excellent returns on capital)
• Debt/equity < 0.8 (conservative leverage)
• Operating margin > 15% (pricing power and efficiency)

Stability filters:

• Beta < 1.2 (not excessively volatile)
• Institutional ownership > 60% (professional investor confidence)

These strict quality filters return only 31 stocks. Each one represents a business that institutional investors prize and that generates consistent profits with manageable debt.

Step 2: Identify a Candidate

From the filtered list, one stock stands out: a technology services company we'll call "TechServices Corp." (fictional for illustration). Here's the snapshot:

• Business: Provides enterprise software and consulting services
• Market cap: $45 billion
• P/E ratio: 22
• EPS growth (5-year): 12% annually
• ROE: 24%
• Debt/equity: 0.35
• Operating margin: 20%
• Current price: $142

At P/E 22, this isn't a screaming value. But for a high-quality compounder, it's not overpriced either. The question is: can we sell puts at strikes where assignment creates genuine value?

Step 3: Analyze Business Quality in Depth

Researching TechServices Corp. reveals:

Competitive moat:

• Deep customer relationships with Fortune 500 clients
• High switching costs once integrated into client operations
• Recurring revenue from maintenance and subscription contracts (65% of total)
• Network effects as more users adopt the platform

Financial consistency:

• Positive earnings every quarter for 10+ years
• Revenue grew every year including during 2008-2009 recession
• Free cash flow conversion rate above 90%
• Consistent share buybacks and dividend growth

Management quality:

• CEO has 15-year tenure with strong track record
• Insider ownership aligned with shareholders
• Conservative capital allocation with disciplined acquisitions

This is a wonderful business. The kind you'd hold for decades and forget about. Exactly what we want for put selling, because if assigned, we're not buying a turnaround hope. We're buying a compounding machine.

Step 4: Calculate Intrinsic Value

Using Wall St Yardie, we estimate fair value:

• Current EPS: $6.45
• Growth rate assumption: 10% (conservative, below historical)
• Discount rate: 10%

The discounted growth model calculates intrinsic value around $155 per share.

The stock trades at $142, roughly 8% below our fair value estimate. That's a modest discount but not deep value. However, for put selling, we're not buying at $142. We're setting strike prices where we'd be thrilled to own shares.

Step 5: Determine Put Strike Strategy

Here's where put selling differs from simply buying stock. We can choose our entry price.

Option chain analysis for 45-day expiration:

Analyzing the choices:

The $140 strike offers the highest premium (2.1% for 45 days, annualized ~17%) but only 9.7% margin of safety. If assigned, we're buying just slightly below current price.

The $125 strike provides nearly 20% margin of safety but pays only 0.4%, which barely covers opportunity cost.

The $130 strike hits a sweet spot: 16% discount to intrinsic value and 0.8% premium (roughly 6.5% annualized). If assigned, we're buying a wonderful company at a 16% discount to fair value. If not assigned, we pocket nearly $100 per contract.

We select the $130 strike.

Step 6: Evaluate Risk/Reward

Let's model the outcomes:

If stock stays above $130 (most likely):

• Premium collected: $102.50 (using $1.025 midpoint)
• Cash required: $13,000 per contract
• Return: 0.79% for 45 days (6.4% annualized)
• Outcome: Keep premium, repeat the process

If stock falls to $130 and we're assigned:

• Purchase price: $130 per share
• Effective cost basis: $130 - $1.025 = $128.975
• Discount to intrinsic value: 16.8%
• Outcome: Own a wonderful business at a great price

If stock falls significantly below $130:

• We own shares at $128.975 effective cost
• Paper loss exists, but we hold a quality compounder
• Can sell covered calls to generate additional income while waiting for recovery

Every outcome is acceptable. We either collect income on capital safely set aside, or we acquire a business we wanted at a price we predetermined was attractive.

Step 7: Verify Event Calendar

TechServices Corp. last reported earnings 5 weeks ago. Next earnings are 8 weeks away. Our 45-day option expires safely before the announcement.

No investor days, product launches, or regulatory events appear scheduled. The calendar is clear.

Step 8: Execute the Trade

The complete position:

1. Set aside $13,000 cash (or margin capacity if using margin)
2. Sell 1 put contract at $130 strike, 45 days to expiration, for $1.025
3. Collect $102.50 premium immediately

Monitoring plan:

• If stock drops toward $130, reassess fundamentals. As long as the business remains strong, prepare for potential ownership.
• If stock rises or stays flat, watch time decay erode option value.
• Around 21 days to expiration, consider closing if 50%+ of premium captured.
• At expiration, accept assignment if below $130 or let expire worthless if above.

Comparing to Direct Stock Purchase

Why not just buy the stock at $142 if we like it?

Direct purchase at $142:

• Own shares immediately
• No premium collected
• Full market exposure from day one

Put sale at $130:

• Might never own shares (if stock stays above $130)
• Collect $102.50 premium either way
• If assigned, buy 8.5% lower than current price
• Defined maximum purchase price

The put sale creates a "limit order with income attached." We've said, "I'll buy this at $130" and received money for that commitment. If the market never reaches our price, we keep getting paid to wait. If it does reach our price, we're buying at a discount we predetermined was attractive.

For investors building positions gradually, put selling offers a systematic entry mechanism that generates income throughout the process.

What Could Go Wrong?

Stock crashes on bad news: If TechServices Corp. announces a major contract loss and drops to $100, we're assigned at $130 and immediately down 30%. The premium doesn't come close to covering this loss. Solution: Only sell puts on businesses you've thoroughly vetted. Unexpected disasters still happen, but thorough research reduces frequency.

Opportunity cost: If TechServices soars to $180, our $130 put expires worthless. We collected $102.50 but missed $38 per share in gains. Solution: Put selling isn't for maximizing upside. It's for generating income while waiting for attractive entry prices. Accept the trade-off.

Premiums shrink: If volatility drops, future puts might pay only 0.4% instead of 0.8%. Solution: Adjust strike selection or wait for higher volatility periods. Quality businesses are worth waiting for.

Assigned into weakness: Getting put shares during a market correction means holding through paper losses. Solution: Only sell puts on businesses you'd hold through downturns. If the fundamentals are strong, temporary paper losses don't matter.

Rolling required: If the stock approaches your strike and you want to avoid assignment, you might roll the put to a later date, potentially at a loss. Solution: Define your decision framework upfront. Are you happy to own shares if assigned, or do you prefer to roll? Know before you trade.

Next Steps

• Build a quality-first screen: Emphasize business quality metrics before valuation when screening for puts.
• Calculate intrinsic values: Use Wall St Yardie to determine fair value for each candidate.
• Set strike prices below intrinsic value: Ensure any assignment creates margin of safety.
• Analyze premium/risk trade-off: Choose strikes where you're comfortable with all outcomes.
• Verify clear calendars: No earnings or events before expiration.
• Start with one position: Experience the put selling process before scaling.
• Read related concepts: Review Why Value Investors Love Selling Puts to understand the philosophical fit. See Strike Price Selection for optimizing your strike choice.

Put selling turns patience into income. You've identified a wonderful business at a price you'd love to pay. Instead of hoping the market delivers that price, you commit to it and collect income while waiting. If the price arrives, you're buying at a predetermined discount. If not, you keep getting paid. Either way, disciplined selection ensures every outcome aligns with your long-term wealth building. Keep the riddim steady, set your price, and let the market come to you.