More MSFT PUT info from Barrons:
Microsoft's Other Business
Is corporate put-selling doomed?
By Erin E. Arvedlund
Are the days of easy money-selling put options in a bull market-going to be
over soon? Take Microsoft, Wall Street's biggest seller of put warrants.
Microsoft, and to a lesser extent Intel and Dell Computer, has sold millions of
puts against its own stock, usually in conjunction with share-buyback
programs. The companies use the money from selling puts to help finance the
repurchase of shares.
That strategy worked perfectly when Microsoft's stock kept rising, because
the puts expire worthless. However, Microsoft's stock slid to a 52-week low
of 65 on April 24, as investors wrung their hands over the prospect of a
government-mandated break-up of the company and a slowdown in the PC
industry.
Until recently, selling puts has amounted to a free-money trade for a lot of
technology companies. Back in 1994, Microsoft's then-CFO Gregory Maffei
pioneered the hedging technique wherein the software giant sold put options,
then used the premium to buy back Microsoft stock. (He left to head newly
public 360networks.) Dell, in some quarters, has made more money selling
options than selling computers, notes Alex Jacobson, founding member of
Chicago's Options Institute.
The companies win in several ways: If the puts expire worthless, they keep a
pile of money in premium. Moreover, income from selling puts is tax-free.
Microsoft pulled in $472 million in the six months ended December 31, 1999,
just from selling put warrants, compared with $355 million in the year-earlier
period. Why? "A company doesn't recognize a gain or loss when it deals in its
own stock," explains Robert Willens, tax-accounting analyst with Lehman
Brothers.
What if the stock collapses further? In recent weeks, Microsoft's stock did
what no one thought it ever would do-it fell, and well below the strike price of
some puts it sold. All of a sudden, in-the-money puts the company sold are
worth something. Investors who bought them have the right to put more stock
back to Microsoft.
As of December 31, Microsoft had 163 million warrants outstanding with
strike prices ranging from $69 to $78 a share. The put warrants expire
between June 2000 and December 2002.
Worst case, what if the stock drops to zero? Here's an imperfect estimate that
gives some hint of the magnitude of Microsoft's put-selling program: Taking an
average of the two prices ($73.50), if the company had to buy back all the
stock covered by these warrants, it would have to spend roughly $12 billion.
Since Microsoft has about $21 billion in
cash, they could probably pay that off
without a hit to earnings. Moreover, it's
doubtful that all the puts would be
exercised, especially if the stock
rebounds. The point is, Willens says,
"They're going to have to revisit this
strategy, just like any other put seller.
How confident is Microsoft in their
stock price? Should they hedge it even
further?"
A savvy corporate treasurer would
even sell puts at a time when the stock
was taking a hit but the outlook for the company was healthy. The stock
craters, volatility skyrockets, and the premiums, or prices of these puts, grow
rich. He or she would make a bet the stock rebounds, sell millions of these
expensive puts and wait for them to expire worthless.
Who buys these puts? Mostly Wall Street banks that structure the programs
for corporate issuers. One banker who bought puts from Microsoft argues
that put-selling actually makes even more sense now as the underlying stocks
trade more unpredictably. "We're buying that volatility from the companies,"
he insists. "The way stocks are acting these days, we end up paying more for
the puts than we did before."
It's true. Back in December, Microsoft stock was trading around 110, and a
one-year January 2001 put with a strike price of 72 was fetching about
$4.70. Today, with the stock around 69, that same put option is going for
roughly $11.50.
Moreover, the banks end up supporting Microsoft's stock price, since they
hedge put positions with massive amounts of stock. The day the bad news of
Microsoft's fate broke, nearly 150 million shares traded; of that, the banker
estimates that 25 million shares were traded by banks like his hedging the puts
they'd bought.
What can retail investors learn from this? First, sometimes blue-chip stocks
move for reasons not related to fundamentals, but because of options.
Second, it makes sense to scour the headlines and securities filings for
companies announcing big share buybacks and put-warrant programs.
"They'll be targets for put sales," the banker explains. "And it could be an
indication that the stock is going higher." |
