Goldman believes they have found a way to take advantage of market inefficiencies caused by corporate stock buyback programs.Essentially, sell over-valued puts for companies you like, that are also likely to buy back their stock.
If you sell puts that are only slightly out of the money, then due to volatility there’s a good chance you’ll end up owning the underlying shares, for a cheaper price than if you had bought them outright.
Barron’s: The study, authored by Anthony Carpet, Laura Conigliaro, Robert Boroujerdi, Maria Grant and Deep Mehta, concludes that selling puts is an attractive way to buy stock, or increase exposure, to companies with large buyback programs.
They found buyback programs potentially reduce the implied volatility of put options. And that may have broader implications for options volatility, which is the most important part of options prices.
Furthermore, 2010 could be a big year for buybacks:
To be sure, this buyback-volatility thesis, both for puts and for overall implied volatility, will be tested in 2010.
Many corporations’ hoarded cash during the credit crisis as they were as unsure as individual investors as to what might occur. Goldman’s analysts opine that low interest rates and big cash piles will now prompt many companies to take action. They think stock-buyback programs may prove popular.
Here are Goldman’s guidelines, emphasis added. Everyone should definitely perform their own due diligence. Also, note that these studies frequently end up doing worse than their seemingly brilliant back tests, and simply generate commissions for the brokers. Still, the buy back inefficiency makes a lot of sense.
* Sell puts that expire in six months and that are 5% out-of-the-money. This means the puts increase in value if the stock price declines by 5%. Of course, investors can pick any strike price that they wish but that changes the probabilities of simply collecting money for selling puts and buying stock.
* Six-month implied volatility is higher than three- and six-month realised volatility, indicating that the options market thinks the stock has a greater chance of moving in the future than in the past.
* Put volatility is elevated, as evidenced by “skew” — the difference between out-of-the-money put and call implied volatility — being higher than the average Standard & Poor’s 500 stock.
* Buy- or Neutral-rated stocks that have not yet exceeded Goldman’s price targets. [Given that this comes from Goldman, of course!]