Goldman Sachs analysts John Marshall and Katherine Fogertey analyze overwriting stocks for the month of November, 2013 with stock candidates Tesla Motors Inc (NASDAQ:TSLA), 3D Systems Corporation (NYSE:DDD), Iron Mountain Incorporated (NYSE:IRM), Sears Holdings Corp (NASDAQ:SHLD). More details on Tesla Motors Inc (NASDAQ:TSLA) and the other stocks below.
Also see Tesla Motors Tops Goldman’s Overwriting List
Since November expiration, we estimate the average US stock with liquid options is up 0.7%; overwriting with 10% OTM 1-month options has outperformed by 5bps, while put selling outperformed by 23bps. Over the past month, 1-month implied volatility on the average S&P 500 stock has declined about 2 points to 18, the second lowest level on record. In comparison, implied volatility on the S&P 500 INDEX (INDEXCBOE:SPX) has remained constant monthon- month, with the current level of 10 still 2 points above all-time lows. Among the sectors, volatility is at an all-time low for Technology stocks (average XLK = 19) but nearly two points above the lowest levels for Discretionary stocks (average XLY = 21). Given the strong outperformance of equities over credit (since Oct 9th) and our expectations of seasonal pressure on volatility, we continue to see overwriting stocksas attractive on single stocks without events.
Overwriting ideas: Tesla Motors, 3D Systems, Iron Mountain, Sears
We screen for the top 1-6 month overwriting candidates Tesla Motors Inc (NASDAQ:TSLA), 3D Systems Corporation (NYSE:DDD), Iron Mountain Incorporated (NYSE:IRM), Sears Holdings Corp (NASDAQ:SHLD) based on our 16-year study as well as our analysts’ fundamental ratings and price targets. We estimate overwriting larger-cap stocks that have high implied volatility but are not reporting earnings in the month added more than 500bp annually from 1996-2011 (study overview, p. 9-11). We identify the most attractive stocks (Tesla Motors, 3D Systems, Iron Mountain, Sears Holdings) to overwrite for December expiration based on this screen (p. 3). For 3-6 month overwrites, we highlight the top 50 opportunities based on our analysts’ price targets as well as the top 50 put selling candidates based on our analysts’ estimates. Covered call sellers risk limiting upside to the strike price plus the option premium and dividends. Put sellers commit to buying shares at the strike price.
Call selling outperform
Call selling outperformed by 5bps while put selling outperformed by 23bps since November expiration. We calculate the average return for a portfolio of 386 stocks in the US market we believe are liquid (as identified by tight bid/ask spreads for 10% OTM calls). We observed that call selling outperformed a long stock strategy only in months with moderate to down stock performance, whereas put selling outperformed in most of the months except in months with sharp market sell-offs. See Exhibit 1.
Buy-write portfolio
Buy-write portfolio (call sale + long stock) is up 0.8% since November expiration: We simulate owning stock and selling 10% OTM December calls as of November expiration. We track this portfolio through the month to judge how single stock overwriting has performed. We estimate this portfolio is up 0.8% compared to the average stock performance of up 0.7%. See Exhibit 2.
Selling portfolio
Put selling portfolio (put sale + long stock) is up 0.9% since November expiration. We track this portfolio through the month to judge how single stock put selling has performed. We estimate this portfolio is up 0.9% compared to the average stock performance of up 0.7%. See Exhibit 2.
We identify short-term overwriting opportunities (1 month) as well as longer-term overwriting opportunities (3-6 months) for Tesla Motors Inc (NASDAQ:TSLA), 3D Systems Corporation (NYSE:DDD), Iron Mountain Incorporated (NYSE:IRM), Sears Holdings Corp (NASDAQ:SHLD) based on two primary methods.
Short-term overwrites (1 month): Tesla Motors, 3D Systems, Iron Mountain, Sears
We focus on Events, Market Cap and implied volatility. Our overwriting study for Tesla Motors Inc (NASDAQ:TSLA), 3D Systems Corporation (NYSE:DDD), Iron Mountain Incorporated (NYSE:IRM), Sears Holdings Corp (NASDAQ:SHLD) shows that event timing and stock characteristics are particularly important factors for overwriting outperformance with short-term options. We identify stocks such as Tesla Motors, 3D Systems, Iron Mountain, Sears Holdings that do not report earnings prior to the next expiration where their market cap is in the top 2/3 of the universe and their implied volatility is also in the top 2/3. We have found that overwriting stocks with these characteristics has added over 500 bp over the past 16 years. See Exhibit 3.
Overwriting stocks: Longer-term (3-6 months)
We focus on our analysts’ fundamental views. While short-term volatility may drive a stock from its appropriate longer-term value, we believe that over a sufficiently long period of time, the stock should tend toward that value. We use our analysts’ price targets to identify those stocks where calls appear overpriced relative to our analysts’ estimate of where shares are likely to trade. This methodology is consistent with our “Buy-write monthly.” See Exhibits 4-5.
Underwriting stocks (6 months)
Put-selling screen based on average support levels for EV/EBITDA, EV/SALES and P/FCF (6 months). In this screen, we start with Buy-rated stocks such as Tesla Motors, 3D Systems, Iron Mountain, Sears Holdings from the Goldman Sachs Group Inc. (NYSE:GS) coverage universe. The put strike to sell is derived from the average of downsides to the stock price in three scenarios where each of EV/EBITDA, EV/SALES and P/FCF reaches its 10%-ile value in last ten years and is based on our analysts’ 12-month forward estimates for EBITDA, Sales, and FCF. See Exhibit 6. All pricing is as of November 27, 2013 close unless otherwise specified.
