Tangible book value per share is assumed to be a corporation's liquidation value, or the net value of all assets if the company simply went out of business and paid off stockholders. It is more likely that companies will cease to exist through merger or acquisition, and at a price somewhere at or above tangible book value. Does the worst-case liquidation value of the company also provide a reliable low market price level for the stock? In practice, your true support level may have little or nothing to do with the fundamental and tangible value of the corporation's assets. Some technicians prefer to identify a chart-based price-support level, but that is also unreliable; the history of trading patterns in any given stock is the history of support and resistance levels being broken through and new trading patterns established. This occurred for many companies during 2008, when nearly half of market value was lost for many stocks, and previously established support levels simply evaporated. In evaluating the likely bottom for a stock, you may want to rely partly on fundamental and partly on technical indicators.
However, your analysis should be based on the original criteria you employed when selecting the stock. Remembering the rule that option activity should be restricted to options on stocks that you have prequalified on a conservative standard, consider what, in your opinion, is a realistic bottom price range. With this analysis in hand, compare the difference between strike price and the probably lowest price level to the premium you receive upon selling the put. If the gap between a particular strike price and lowest likely price level is 3 points and you can sell a put for 5 points, then even given your perceived worst-case scenario for the stock, you will be ahead. This risk-free description, the worst case, allows for the possibility that the stock would be put to you upon exercise at a price above current market value. So, if the market value of shares were to fall below the put's strike price, you would be required to buy inflated-value stock.
Establishing the lowest likely price range may not be easy; it is a matter of opinion. A study of recent price trends may help, but determining the level is far from an exact science, and it is at least as difficult as identifying the likely highest price to which a stock might rise. This is why comparisons between price trends and tangible book-value-per-share are useful. If you are uncertain about the reliability of price-support level, tangible book value per share may provide a more comfortable "drop-dead price" and fundamental support level. This is especially true for the dedicated fundamental analyst. Because tangible book value per share is a fundamental indicator, it may be viewed as more reliable than the technical concept of price support level for judging risk.
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