How to Buy GlaxoSmithKline at a 15% Discount

 Investors seeking more returns can not only get some yield, but also healthy dividends from buying options on stocks. Those who are seeking additional opportunities can purchase GlaxoSmithKline (GSK),

Since the presidential election, markets have been on an upswing, but investors seeking more returns are not only able to get some yield, but can also lower their risk and increase yield by selling options.

As the markets rallied, the major indexes reached all-time highs and the U.S dollar hit a 14-year high, investors who are still seeking additional opportunities can purchase GlaxoSmithKline (GSK) , which is "cheap and pays a decent dividend," said Ron McCoy a portfolio manager with Covestor, the online investing company, and founder of Freedom Capital Advisors in Winter Garden, Fla.

        

As one of the U.K.'s big pharma companies, GlaxoSmithKline has a yield of 4.8% and traded at $37.72 on Friday, falling to its 52-week low. GSK trades at 13.5 times its 2017 earning estimates, which is inexpensive compared to the S&P 500.

"Investors can use options to further reduce their cost and lower their entry point," he said.

In his Covestor fund, the May $32 puts were sold and collected $0.55 per contract, "which we believe would be an extremely attractive entry point on the stock" McCoy said.

A seller of puts is obligated to buy the stock at the strike price of $32 up until the expiration and is paid a premium for taking the risk, he said. Since the May $32 puts are trading around $0.55 or $0.60 per contract, if an investor was assigned or "put the stock," it would result in a net cost on GSK of $31.40.

"That would be equal to just over 11 times its 2017 earnings consensus estimate of $2.76 which would be very cheap," said McCoy. 

Selling one of the $32 puts obligates the seller of the put to buy 100 shares of the stock at $32 if the buyer exercises the put.

Distinguishing between a right and an obligation is critical as they are both very different, since buyers of options have rights and sellers have obligations, he said. 

Another attractive option idea would be to do a buy-write, otherwise known as a covered call, with a $47 strike price using the January 2018 calls, McCoy said.

"By selling the calls against the purchase, one could lower their cost on GSK to around $34.50, and if all four dividends are collected and the stock is called away, it would be a return of over 12% in about 13 months," he said. "If it is not called away, the yield would be nearly 6% if you did nothing else which would be an attractive yield by most standards."

Selling Options for Dividend-Like Yields

Selling options will generate a premium which resembles dividend income, regardless if the underlying stocks are paying a dividend, said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla.

"If the objective is to produce or enhance the annual yield of the underlying stock, investors can write calls or write puts in addition to relevant positions in the underlying stocks," he said.

Put writers should always be prepared to buy back the stocks at "higher than market" strike prices and selling puts for income will make more sense if investors intend to own the stocks anyway, Ma said.

"In other words, the put premium received serves to reduce the cost basis of the stocks," he said. "In order to keep the put premium or owning the stocks, investors should be bullish on the stocks."

On the flip side, call writers should always be prepared to sell the stocks at "lower than market" strike price, Ma said. Selling calls for income will make sense even more if investors intend to sell the current overpriced stocks anyway.

"The call premium received, other than like a dividend income, serves to capture the overvaluation of the stocks," he said.

In order to keep the call premium or selling the overpriced stocks, investors should be bearish on the stocks.

"In either case, it stands to reason that the 'synthetic dividend yield' generated from writing options is riskier than the actual dividend yield received from owning the stock," Ma said. "The option premium should exceed the expected dividend yield of 2% to 3%,nowadays."

By Ellen Chang

Source: https://www.thestreet.com/story/13912669/1/how-to-buy-glaxosmithkline-at-a-15-discount.html