Why would you ever hold onto a stock that's overvalued?
Real Money Columnist Paul Price recently discussed the answer.
In March, 2020 Price picked up shares in LPL Financial (LPLA). At the time, his shares cost $52 apiece. The stock was down considerably from the company’s previous share price of nearly $100. It recovered to nearly $140 in 2021, when Price still recommended buying LPLA, and then to almost $200 per share in 2022.
At $196 per share Price decided that the stock had hit and exceeded all of his goals. So what did he do?
He held on to a bunch of shares.
“LPLA is a fine company with good long-term prospects,” Price wrote recently on Real Money. "That said, the stock is no longer bargain-priced at 22.5-times its 2022 estimate. The current yield is now a well below average 0.54% as well… Why do I still have these 600 shares then?”
The answer is options.
While investors can open a standard long position in many stocks, buying and holding in anticipation of capital gains, you can also use stocks to hedge and cover options positions. This is a more sophisticated form of trading than many retail investors use, but it can allow you to make money even when the price of a stock falls.
In the case of LPLA, Price wrote, “I sold covered calls on them a while back at $170 and $175 strike prices. The $170 calls brought in $7.23 /share. The $175 strike price call was sold later, at $14.50/share."
In addition, "Naked puts I sold when LPLA was much lower have all expired worthless already (the best-case scenario for any option seller). I'm still short two contracts of LPLA's July 15, 2022 expiration day $160 puts, which were written with LPLA at about $168.”
With the options contracts that Price has sold, his shares in LPLA provide him cover in case the contracts expire in the money. If that happens he won’t have to go out and buy a bunch of high-priced shares. He’ll already have a portfolio filled with shares that he bought dirt cheap. If the contracts expire out of the money, then he can decide whether to sell new ones or sell his potentially overvalued stocks.
Either way, though, by holding shares of an overvalued stock, Price gives himself room to move.
