How We Find Good Companies to Trade

When we trade options the most important part is to find good companies to trade. When we trade options we’re sellers, not buyers. We mostly do wheel trades, selling a cash secured put on a company we want to own at a strike price we’re happy to own it at. We usually do that several times before we are assigned shares. That means once were assigned shares our cost basis is below the assignment strike.

Once we have shares we sell covered calls on some (but not all) of those shares. So if we sell five contracts of puts and get assigned, we might sell calls on three contracts. That way we reduce our cost basis per share across all of the shares that we own, but if the company runs up through our call strike and we get called away we’ll still own some shares. We’ll usually sell covered calls several times before having the shares called away. So we reduce our cost basis on the front end with puts, then again with covered calls and any dividends.

After that process runs its course we usually end up with a tranche or two of shares that we own free and clear (zero or negative cost basis). Then we can let those ride indefinitely or until something changes with the company or situation.

Watching the Experts

The big risk with this approach is if we sell our first tranche of puts at a price that’s too high. Then the trade price of the underlying company could crash through our put. We could get assigned shares and the trade price could keep dropping. Then we’d have a tranche that’s too high for generating much premium on the covered calls. This is why it’s so important that we find good companies to trade. One way we prevent ourselves from making that mistake is following the expert fund managers. The guys running funds with over $100 million in assets must file their portfolio activity with the SEC with a Form 13F each quarter. They have until 45 days after the end of the quarter to make the filing.

Using the 13Fs

These fund managers have more resources than most of the rest of us, and it’s reasonable to think they’ve done their research before they enter or exit a position. It does not, however, mean they don’t make mistakes. So we compiled a list of the fund managers we like. Each quarter we go through the 13F forms for each of the funds.

The primary thing we’re looking for is duplicate transactions between the fund managers. When we see more than one of the fund managers buying the same company it bubbles up for us. Then we do more research on that company. We also look at transactions that were a larger percent of each individual fund manager’s portfolio. That gives us a short list of companies to review with other criteria which helps us find good companies to trade. Here’s our short list for the most recent 13Fs: CPRI, WSC, OXY and TSM.