On April 11, I published a Tear Sheet (see below) to Framework members detailing an option investment in the bellwether of “Old Tech” – IBM.

The company was scheduled to report earnings for the first quarter of 2018 in a week, so option prices on Big Blue were relatively high. Using the investing dictum of Buy Low, Sell Dear, we sold put options on IBM’s shares – effectively acting as an insurance company and accepting the risk of a stock price drop in return for a premium payment.

A week later, when the company reported its earnings, its shares fell heavily.

Figure 1.

For option traders, this price drop would have been terrible. For option investors, the price drop represents mostly noise over signal, and we believe we are in a “heads you win, tails you win” situation.

We reviewed the earnings announcement and published comments to our membership, then discussed IBM in several of our weekly “Office Hour” web conference calls. Long-time members have been hearing me talk about IBM for several years – I first picked up coverage of the company in 2015 and invested in it in 2016 – so my comments did not come as a surprise to them.

Newer members, however, had a lot of questions:

  • How did you select your strike price?
  • How did you pick the expiration date for the option you sold?
  • What happens if the put option expires In-the-Money (ITM)?
  • How do you have the confidence to accept IBM’s downside price risk?
  • How can you manage this position going forward?
  • Should I close the position at a loss or increase the size of my position after the drop?

These are all reasonable and important questions, and in discussing them, I realized that a lot of people who are experimenting with option investment strategies have the same questions.

One of Framework’s partners, Ms. Sheila Chesney – who worked for IBM for years, but who has spent the last 22 years running an innovative registered investment advisory practice for high net worth families – urged me to publish an ongoing case study of our investment in IBM. This case study format would show people step-by-step how we valued the company and structured the investment.

We will publish several articles outlining our approach, then will update readers periodically as we manage the position. Two of the introductory articles will focus on options transaction and two will focus on valuation:

  • Selecting Tenor And Strike Price
  • Confidently Assessing IBM’s Intrinsic Value
  • Taking A Scientific Approach To Valuation
  • Managing An Option Investment

In my mind, it is foolhardy to invest in any security – stock, bond, or option – without understanding the true value of the company underlying that security. It is for this reason that we give equal time to questions of valuation as we do to questions about options.

Our Tear Sheet is below. If you would like to participate in an Office Hour session regarding the IBM investment idea, please send me an email and I will send through an invitation (20 seats available in total).

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