Using Tranches to Buy a Company

We’re going to use tranches to buy a company. We’ve found a company we like that’s in our buy zone and we’re ready to acquire some shares. But we’re not going to fire away with all of our capital at one time. Instead we’re going to break up our capital for the company into five batches.

Let’s say we have a company that’s trading at $50 and we’re comfortable buying shares at that price. We have $30,000 in our portfolio that we’re comfortable allocating to this company. Do we buy $30,000 worth of share right now? Or do we use tranches to buy the company?

We’re going to split up our $30,000 that we’re happy to allocate to this company into smaller buckets. With the company trading at $50, we’re going to buy 100 shares of the company outright. That’s $5,000. And that leaves us with another $25,000 to allocate.

We’re also going to sell a put option at the $49 strike for the upcoming expiration date.  Selling to open that put option obligates us to buy 100 shares of the company at the $49 strike. So that’s another $4,900. We’ll get paid the option premium to enter into the put option contract. In this case we’ll get $0.44 per share to enter the option contract, or $44 in total. If the company drops below our strike and is trading below $49 at expiration, we’ll be obligated to buy 100 shares of the company at $49. But we’ll also have collected the $0.44 in option premium for each share of the contract.

Here’s how this looks to start:

Buy 100 shares at $50 = $5,000

Sell to open one put option contract at the $49 strike

Bring in $0.44 in option premium = $44

Our basis per share if not assigned shares is $5,000 – $44 = $4,956. Since we have 100 shares our basis will be $49.56 per share.

If assigned at $49 we’ll have 100 shares at $50 = $5,000 and 100 shares at $49 = 4,900. That’s $9,900 for 200 shares minus the $44 in option premium, or $9,856 for 200 shares = $49.28 per share. Here’s the template we use to help us track this basis.

If the company continues to trade above our $49 strike price through expiration our put option contract will expire worthless. We’ll keep the option premium and then sell another put for the next expiration date. By selling to open a new put option contract each time one contract expires we’ll be able to earn passive income on the option contract. If the share price of the company drops we’ll be using tranches to buy the company at lower and lower strike prices. The trading price of the company might stay above $50 and if that happens we’ll reduce our basis a little each week with the passive income from the options premium.

If we allocate our full $30,000 at once when the company is trading at $50 per share and the trading price drops, we’ll have a full allocation at $50 and we won’t be able to sell puts for passive income and to reduce our basis. We’ll also not be able to dollar cost average into our position. The risk in using tranches to buy a company is that the company could quickly start trading higher. If that happens then would only hold a few tranches of shares rather than owning a full allocation of shares.