This month’s options expiration freed up significant additional cash in my accounts and as a result I’ve been looking for places to deploy some of it. But high prices and low volatility weren’t making it easy to find good returns.
That changed significantly this past week. Concerns over China and the overall global recovery, questions over Bernanke’s reconfirmation, and yet even more unproductive (to say the least) rhetoric from Washington all sent stocks sharply lower and the VIX spiking all the way back up to over 27.
As a result I took the opportunity to initiate a number of new short put option positions (see below). At the same time I’m mindful that there’s plenty of room for the market to fall further if it chooses to do so, so as usual I’m placing conservative bets on quality companies and keeping plenty of “powder dry” for if/when better opportunities present themselves.
Freeport McMoran [[FCX]] – On 1/20/10 I bought to close some January 2011 25-strike LEAPS put options I had sold against FCX in my IRA on 1/6/09 (as part of a defensive move of rolling out and down some February ’09 45-strike puts originally sold in September ’08) as they were trading at a tiny fraction of their original selling price, resulting in a 16-month net return of about 6.8%.
Ameren [[AEE]] – On 1/22/10 I sold some September 22.5-strike put options against AEE as it fell on market weakness:
I’m currently already long some shares (at higher prices) of this electric utility, which operates in Illinois and Missouri. Early last year I reduced my original losing position in this stock at almost no cost using a short put options strategy and now I’m looking to either reduce the cost basis of my remaining position, or average down through the purchase of some more shares at lower prices.
Trading at about $26 and yielding almost 6%, the shares remain in an intermediate-term uptrend. A break below the $24-$26 level would indicate a more neutral to negative outlook.
Fundamentally AEE appears about fairly valued at these levels, with what should be a sustainable dividend. I’d be comfortable owning more in the low $20s, which would be my cost basis on the new shares if I’m ultimately put the stock.
Applied Industrial Technologies [[AIT]] – On 1/22/10 I sold some August 20-strike put options in my IRA against AIT as it sold off on market weakness:
Applied Industrial Technologies distributes various industrial parts in North America and provides a variety of engineering and repair services to industrial companies, such as Vulcan Materials. AIT was included as a “deep value” pick in Fortune Magazine’s 2008 Fortune 40: Best stocks to retire on and is listed among the holdings of the Royce Special Equity Fund, a fund that combines small-cap value investing with “accounting cynicism.” (See an interesting WealthTrack interview with Charles Dreifus, the fund’s manager.)
Trading at about $23 and yielding a little over 2.5%, AIT’s shares remain in a clear short- and intermediate-term uptrend, despite reporting lower-than-expected fiscal second-quarter earnings earlier in the week. A break below the $21-$22 level would suggest a more neutral to negative outlook.
Current fair value estimates for AIT range from about $17 to almost $30, so it appears roughly fairly valued here. However a clean balance sheet, a consistent dividend record, and a forecast double-digit earnings growth rate over the next five years make it seem reasonably attractive, especially at a price of under $19, which would be my cost basis if ultimately put the stock.
Banco Santander, S.A. [[STD]] – On 1/21/10 I sold some June 12.5-strike put options against STD as it fell on weakness in the sector:
Banco Santander is a large commercial and private global bank headquartered in Spain. It’s a solid bank with decent growth prospects and exposure to emerging markets in Latin America.
Currently trading at about $15 and yielding around 3.7%, its shares are retreating from recent highs at around $18 after having run up there almost in a straight line from their March $5 lows; so a pullback here back down to the $11-$12 area in the coming weeks/months would certainly not be unexpected.
Valuation wise, STD is probably roughly fairly valued at current levels (~$15). I’m comfortable with the idea of owning it at $12 (or lower), which would be my cost basis if it’s put to me, with what should be a corresponding dividend yield – after an 18% Spanish withholding tax – of 4%+.
The Chubb Corp. [[CB]] – On 1/21/10 I sold some July 45-strike put options against CB as it fell on market weakness:
Trading at $48 and yielding almost 3%, the shares of this property and casualty insurance provider remain in an intermediate-term uptrend but – like the market – are currently in a shorter-term downtrend. A break below the $45-$46 level would change this picture to something more neutral/negative.
From a valuation perspective, CB appears undervalued here, with current fair value calculations ranging from about $40 to over $100. The Chubb Corporation has a long history (44 years) of dividend increases, earning it the distinction as an S&P 500 Dividend Aristocrat.
I’m already short some April 40 put options that I sold against CB in my IRA last October, but those will be increasingly losing time premium in the coming weeks and seem – at this point anyway – unlikely to end up in the money. The July puts are another story, but I’m very comfortable with the idea of owning CB at the $43-$44 level (and corresponding 3.2% yield), which would be my cost basis if I end up being put the stock.
FPL Group [[NEE]] – On 1/22/10 I sold some September 40-strike put options against FPL as it fell on market weakness:
Currently trading at about $48 and yielding almost 4%, the shares of this Florida public utility are in a clear short- and intermediate-term downtrend and appear poised to retest the $45 level at some point. The current weakness can be blamed in large part on the Florida Public Service Commission’s recent decision to deny most of the utility’s rate increase request.
While this is not good news for the stock, which traded as high as the mid $70s two years ago, fundamentally the shares now appear to be roughly fairly valued. Calculated valuation estimates range from the high $30s up to over $70.
FPL has a good dividend history – it has raised its dividend for 14 consecutive years and has a five-year dividend growth rate of almost 8%. While the dividend growth may be called into question in the nearer term, the current payout seems sustainable, and I’d be comfortable owning the shares below $40 (with a corresponding 4.9% yield), which would be my cost basis if I’m ultimately put the stock.
IBM [[IBM]] – On 1/20/10 I sold a January 2011 115-strike put option against IBM as it fell on market weakness:
Currently trading at about $125 and yielding 1.75%, the shares of this large computer-services provider are clearly in a strong and extended intermediate-term uptrend but showing short-term weakness, which could certainly develop into a move back to the $110-$115 level. A break below $110 would change this picture to something more neutral/negative.
Valuation wise, IBM appears somewhat undervalued here with current fair value estimates ranging from the low $90s up to over $200. It has a good history of dividend growth – 14 years of consecutive increases with a five-year growth rate of over 20% – and is a Dividend Achiever. I’m comfortable owning the stock below $110, which would be my cost basis if it’s ultimately put to me.
JPMorgan Chase [[JPM]] – On 1/21/10 I sold some September 30-strike put options against JPM as it fell on weakness in the sector:
Trading at $39 and yielding 0.5%, the shares of this financial holding company are clearly in a short-term downtrend within a still intact intermediate-term uptrend. A break below the $35-$36 level would suggest a more neutral/negative picture.
Fundamentally, current fair value estimates for JPM range somewhere in the mid- to upper-$30s, which the stock is fast approaching. And it seems likely that the uncertainty from all the bank bashing going on in Washington may create buying opportunities at lower prices among the big bank stocks.
This by itself doesn’t especially interest me, but I was intrigued by the possibility/likelihood that JPM may reinstate a dividend later this year. As a result, I’m comfortable with the idea of owning JPM at under $30 (with a potential yield of around 3%), which would be my cost basis if I’m eventually put the stock.
Kraft [[KFT]] – On 1/21/10 I sold some September 25-strike put options against KFT as the shares sold off after the announcement of the Cadbury deal:
Trading at about $28 and yielding over 4%, the shares of this packaged foods products company are in an intermediate-term uptrend but experiencing short-term weakness. A break below the $26-$27 level would change this picture to something less positive.
Fundamentally, KFT appears roughly fairly valued here, with valuation estimates ranging from the low teens up to the high $30s. The Cadbury acquisition would seem to offer Kraft some longer-term positives given the former’s ties in emerging markets, although such mergers are not without implementation risks.
When all is said and done, and barring any significant negative changes in the fundamentals or the dividend, I wouldn’t mind owning KFT in the low $20s or below. If put to me, my cost basis for the shares will be about $24 with a corresponding dividend yield of 4.8%.
NYSE Euronext [[NYX]] – On 1/21/10 I sold some January 2011 LEAPS 20-strike put options against NYX as it fell on market weakness:
NYSE Euronext comprises several stock and derivative trading exchanges, including the New York Stock Exchange, Euronext, NYSE Liffe and NYSE Amex (formerly the American Stock Exchange), to make one of the world’s largest exchange groups. Profits are tied to trading volume and various fees for data and other services.
Trading at about $24 and yielding 5%, NYX shares have been underperforming the market since the middle of last year and present a current intermediate-term technical picture that can probably be described as neutral at best. A retest of the $19-$20 support level appears quite possible.
Valuation wise, NYX generally appears somewhat undervalued here, with an average calculated current fair value of around $26. Caveats include minimal/negative free cash flow, pressures from competition and lower trading volumes – not to mention uncertainties over the proposed “crackdown” on proprietary trading at banks – and a potential decision to change the current generous dividend policy.
All in all while I’d be cautious at current levels, I wouldn’t mind owning some NYX at below $19-$20 (which would be my cost basis if put the shares) for what appears to be a good long-term total return potential.
Williams Partners L.P. [[WPZ]] – On 1/22/10 I sold some September 30-strike put options against WPZ as it dipped a bit intraday during the broad market sell-off:
Williams Partners L.P. is a master limited partnership involved in gathering, transporting, and processing natural gas and storing natural gas liquids. WPZ’s shares jumped earlier in the week when the company announced it was combining its pipeline and processing units to create one of the largest natural gas partnerships in the U.S. (see company’s press release).
Currently trading at about $38 and yielding 6.7%, the units are clearly in a strong short- and intermediate-term uptrend. It would probably take a sharp break below the low $30s to change this picture to something less positive.
Fundamentally, units of WPZ are now trading at about the same distribution yield as investment-grade MLPs, reflecting the expected upgrade of WPZ’s debt to similar status as well as a first-quarter distribution increase of 3.5%. One of my MLP positions was called away at this month’s options expiration, so I’m looking to add another at some point, and I’d be happy to own WPZ at under $29 (with a corresponding distribution yield of about 9%), which would be my cost basis if the units are ultimately assigned to me.