Say company X has a share price of $80. They think their shares are undervalued, and their board approved a buyback of $1 billion. Can company X use the $1 billion to sell puts at $79, with the idea that if the price drops they buy back at cheaper than current market price, while if the price doesn't drop they make a profit and can sell puts again in the future?

I've seen no mention of this method of buybacks anywhere, but it seems to make sense. After all, both results are good for the company. The latter result (the share price goes up) doesn't result in an actual reduction in float, but it does result in a profit, and presumably shareholders won't mind. Is this already being done? If not, why not? Only thing I can think of is that it's illegal, but I don't see why.

  • Interesting idea. Not an answer though. I imagine that one problem with "PUT option buy back plan" would be that company would have to not only short sell $79 PUT options for specific date, but all spectrum of it, because it may otherwise create arbitrage opportunities (assuming company is doing market order). I don't know if stock option market is that efficient to adjust on "big orders". – user389238 May 28 '18 at 2:10
  • @Hans Solo - If you're referring to Discount Arbitrage, that would result in an equal amount of stock buying and selling. If not, what kind of arbitrage opportunity do you think would arise from the company selling short puts? – Bob Baerker May 28 '18 at 2:20
  • @BobBaerker I was thinking among the lines how company could implement such buy back? If company short sells only options with $79 strike price at one expiration date what would happen with premiums for options at different strike prices and expiration dates? As an example, If general public would know that company is short selling options that expire in March, then would April options have suddenly steep premium increase? Although, regular stock buybacks may have the similar problem where approved stock buy back funds run out. – user389238 May 28 '18 at 2:32
  • @Hans Solo - If the company only sells March $79 strike puts, nothing happens with option premiums in other months. March implied volatility (and premium) would be driven down while the other months remained the same. That wouldn't be an arbitrage opportunity. It would be a volatility play (calendars, diagonals, etc) which might or might not work out, depending on what share price did subsequently. Selling pressure on the March $79 puts might lead to Dividend Arb and conversions but for the most part, that just drives option price back into line. – Bob Baerker May 28 '18 at 13:04

In the early 90's, the SEC issued a ruling that allowed companies to sell puts on their stock for the purpose of buybacks.

The short puts don't necessarily assure the company that they will acquire shares because if share price rises, the puts will expire worthless, generating some income, and the buyback isn't accomplished.

OTOH, if share price falls, the company buys the shares back, perhaps at a loss but that isn't relevant since they were going to repurchase shares anyway at current price at the time the puts were sold. The premium received reduces the cost of the buyback program.

There have been a lot of changes in regulations since 1992, particularly with Dodd Frank after the GFC so I don't know if this ruling has been amended or repealed.

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    I'm not a subscriber so I couldn't read the story but a quick Google turned up this Wall Street Journal article: "More Companies Use Options To Gamble on Their Own Stock". – Bob Baerker May 29 '18 at 13:47
  • And also from Google: "Years ago, with Coca Cola stock around $39, Warren Buffett sold 50,000 put options (which represent 5 million shares) with a strike price of $35 for $1.50 per share, making $7.5 million immediately. If the stock price went up before the contracts expired, he would simply keep all of that money. If the price dropped sufficiently, he would be forced to buy Coke stock for $35 per share, a price he liked. Granted, he could just wait and buy if the price dropped to $35, but this way he got $7.5 million no matter what happened." – Bob Baerker May 29 '18 at 13:48

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