Nokia Is Ready To Break Out: Use This High-Reward, Low-Risk Strategy To Get In

Dec. 3.12 | About: Nokia Corporation (NOK)

Nokia Corporation (NYSE:NOK) appears to have scored a big coup with the Lumia 920. If reports on Yahoo China are to be believed, over 2.5 million Lumias were booked or sold in just 20 days. Additionally, when the phones went on sale on Amazon China (NASDAQ:AMZN), they sold out in just 30 minutes. If these figures are true, then just imagine how many phones it will sell in China when the Lumia 920T becomes available to the general public in December.

China is the world's largest mobile market and Nokia should easily be able to sell over 2.5 million phones in China alone. The Lumia 920 sold out in Italy and demand in France was comparable to that of the iphone. The Finnish retailer DNA stated that demand for the Lumia 920 was higher than any other phone from Nokia in the past 10 years. Demand for the phone appears to be strong in other parts of Europe also. In Germany most stores are sold out and demand in the U.S. is also robust with most stores reporting that they are out of stock. Nokia is off to a good start, and now it remains to be seen if the demand is real, for some skeptics feel that the demand appears to be high because supplies of the phone were limited to begin with. Based on the reviews and its performance to date, we think this demand is real, and this will be confirmed once the phone starts to sell in China. The initial reception in China has been great. As stated above when the phones went on sale on Amazon China, they sold out in just 30 minutes.

Nokia scored a major victory by getting China Mobile (NYSE:CHL) onboard to sell the Lumia 920T. China Mobile is the World's largest carrier with roughly 700 million subscribers. China is now the World's largest smartphone market. In the 3rd quarter, 23.9 million smartphones were shipped to China versus the 23.3 million shipped to the United States, the former leader. With a very low rate of 3G penetration (currently below 19%), the growth potential for Nokia is huge. China Mobile is looking for a flagship smartphone to promote its 3G network and its upcoming TD-LTE network, and it looks like it may have found that in the Lumia 920T. There are reports, which state that the Lumina 920T will support China Mobile's TD-SCDMA and TD-LTE networks. If this is true it could be a huge boost for Nokia, as China Mobile's customers will now have a handset that allows them to fully access its 3G networks and eventually its TD-LTE network. China Mobile is the only carrier in China right now that is developing and testing out a TDE-LTE network. It has selected Alcatel-Lucent (ALU) to deploy this network. On a separate note, this could provide one more reason among the many we provided in this article to be bullish on the longer-term prospects of Alcatel- Lucent.

However, even in the best of scenarios there is always a chance that things might not go according to plan, and that is where the bull put spread comes into play. With a bull put spread you simultaneously sell one out of the money put and purchase one put that is farther out of the money for a net credit. The maximum gain is achieved if the price of the stock trades at or above the highest strike price. Your total risk is equivalent to the spread between the two strike prices. This would only occur if the stock closed at or below the lower strike price. As we are also looking for a chance to benefit from the upside, we are going to modify this strategy slightly. The credit obtained from the spread will be used to purchase calls. The calls will provide investors with unlimited upside potential, while the bull put spread will limit your downside risk.

Benefits of a bull put spread

  1. It limits your losses if the stock suddenly plunges. Your loss is limited to the total differences between the strike prices of your short put (the put you sold) and long put (the put you purchased).
  2. The ability to profit even if the stock barely budges in price.
  3. The risk is significantly lower than writing a naked put as your maximum downside is limited by the put option you purchased.
  4. The capital requirements are significantly less. With cash secured put you would need to have enough cash in your account to back the sale of the put. If you sold a put with a strike at $65, you would need to have $6500 in the account. With the bull put spread, your capital requirement is limited to the spread between the two strike prices.
  5. In the event the stock declines, an investor can buy to close the short put position and continue to lock in gains from the long put as the price of the underlying stock drops.

Additional Reasons to be bullish on Nokia:

  • A good yield of 5.4%
  • Zack's has a projected 3-5 EPS growth rate of 6.5%
  • It has an incredible patent portfolio that generates $600 million in revenue each year. This portfolio is estimated to be worth in the billions, with some experts stating that it could be worth more than the company itself if Nokia decided to sell it.

Alexander Butler, executive vice president at IPVision, an intellectual-property consultancy in Cambridge, Massachusetts, says that measured against what Motorola's and Nortel's patents sold for, and taking into account the quality of Nokia's patents, the Nokia storehouse could be worth more than the company's market value, which stood at around $9.6 billion at midday Tuesday.

Over the last 20 years, Nokia has sunk more than $50 billion into R&D and made several acquisitions, producing a war chest of 30,000 patents, including 11,000 filed in the U.S. "The quality of the patents is one of the best in the industry," says Chetan Sharma, a wireless analyst and consultant in Seattle.

  • The company has a strong levered free cash flow of $1.39 billion, and a decent current ratio of 1.3.
  • The short ratio has inched up another 0.2% from 8% to 8.2% in less than 30 days. This high ratio makes it a good candidate for a short squeeze
  • Analysts have a projected growth rate of 20% for the next quarter and 80% for the next year.
  • Its new Lumina 920 phones have some great features, and the initial response has been pretty good. The phone sports a Retina quality display and a top-notch camera that is better than the Apple's (NASDAQ:AAPL) iPhones. The phone itself is built well, with a fast browser and a responsive touch screen. One of the most prominent features is the ability to charge the phone wirelessly. It won't require a special battery cover as this feature is built into the 920. All you have to do is purchase the charging accessory, which could range from a pillow to a speaker and put the phone on top of the accessory and it will power up the battery. In this sense, it leads because as Apple is looking for ways to make its charger smaller, Nokia has eliminated it altogether.
  • The super sensitive touch screen has another very interesting and beneficial feature. The touch screen can be used and controlled even when you are wearing gloves. Now you won't have to remove your gloves if it is freezing and you want to send a text message. There are other interesting features like the city lens, which overlays store information when you point your camera at a specific point in the city. The Lumia 920 provides Nokia with an opportunity to show the world that it is still a force to reckon with.

Charts and data of value

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The orange line represents the valuation growth rate line. Generally, when the stock is trading below this line and in the shaded green area, it represents a good long-term entry point. The stock is currently trading right on this line.

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Stocks tend to perform better when they are trading above the consensus EPS line. While the stock is trading below the EPS consensus line, it should be viewed as a positive development that the consensus EPS line has started to trend upward again. This could provide early investors with an opportunity to establish a position in the stock at a very good price.

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The above chart illustrates the relationship between broker recommendations and price of the stock.

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Nokia and the Competition

The company will be compared against key competitors using key metrics such as P/E, quarterly revenue growth, operating margins, PEG, etc. This will give you further insight into the company, and it could also help you determine if it is the right play for you.

NOK

Industry

Quarterly revenue growth

-0.19

0.27

0.14

Revenue

41.61B

156.51B

193.68M

Gross Margin

0.27

0.44

0.35

EBITDA

-911.47M

58.52B

5.09M

Operating Margin

-0.06

0.35

0.01

Net Income

-5.67B

41.73B

N/A

EPS

-1.53

44.15

N/A

P/E

N/A

13.26

13.39

PEG (5 yr expected):

9.62

0.58

0.66

P/S

0.30

3.54

0.92

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Technical outlook

After bottoming in July, it has been putting in series of higher lows. This usually signals that the worst news has been priced in and that the stock is ready to trend higher, and based on the recent performance of the stock, this appears to be true.

The stock is trading above its 200-day moving average and this is another bullish development that signals higher prices are in the horizon. Yet another short- to mid-term bullish confirmation comes from the fact that the 50-day moving average is trading above the 200-moving day average.

The weekly close above $3.00 is another strong positive development, and clearly indicates that the stock has bottomed out in the short- to intermediate-time frames. Unlesss it closes below $2.20 on a weekly basis, it should continue to trend higher. Over the very short-term time frames, a test of the $3.00 ranges is likely. We would wait for a test of this zone before putting this strategy into play. A weekly close above $3.70 should push the stock to the $5.00-$5.20 ranges.

Suggested strategy

We are first going to write a bull put spread and then the credit obtained from writing this spread will be used to purchase the calls.

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The April 2013, 3.00 puts are trading in the $0.41-$0.43 ranges. If the stock pulls back to the stated ranges, these puts should trade in the $0.55-$0.60 ranges. We will assume that these puts can be sold at $0.55 or better.

The April 2013, 2.50 puts are trading in the $0.21- $0.22 ranges. If the stock pulls back to the stated ranges, the option should trade in the $0.30-$0.35 ranges. We will assume that the puts can be purchased at $0.35 or better. This will leave you with a net credit of $0.20 per spread. This credit will be used to purchase calls in the next step.

If you are happy with just writing a bull put spread, you could stop here. Your total risk in this case will be $30.00, and your maximum gain will be $20.00 for a return of 66.7% in roughly five months.

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The goal here is not to put up any extra money, but to use the credit to fund the purchase of the calls. The April 2013, 4.00 calls are trading in the $0.27-$0.28 ranges. If the stock pulls back to the stated ranges, these calls should trade in the $0.18-$0.20 ranges. If they do not then you can aim for the April 2013, 4.50 calls. We will assume that these calls can be purchased at $0.20 or better. For each bull put spread you write, you will be in a position to purchase one call.

Transaction Details

  1. After you write the Bull put spread and purchase the call you will have a net credit of $20.00
  2. Your maximum risk is $50.
  3. Your breakeven point is $3.00
  4. Your maximum profit potential is unlimited due to the call purchased. Technically there is no limit as to how high the stock could rally.

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Conclusion

The strategy we have outlined is a great way to establish a long position in Nokia without taking on too much risk. The call side of the strategy provides you with the ability to lock in unlimited gains if the stock takes off. The bull put spread limits your total risk to just $50.00

Do not abuse this strategy as there is always a chance that the shares could be assigned to your account. The hedge you have in place via the long put will not prevent the shares from being put into your account. Consider booking some profits when the options are showing gains in the 65%-100% ranges or if the stock trades past $5.00.

Options tables from yahoofinance.com. EPS, EPS surprise and broker recommendation charts sourced from Zacks.com. Competitors data sourced from yahoofinance.com

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was prepared for Tactical Investor by one of our analysts. We have not received any compensation for expressing the recommendations in this article. We have no business relationships with any of the companies mentioned in this article.