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CME Group (NASDAQ:CME) [formerly - the Chicago Mercantile Exchange] completed its acquisition of the New York Mercantile Exchange to become America's largest futures exchange as well as the world's biggest clearing organization for trading futures and options on futures. The four major areas of exchange involve interest rates, foreign exchange, equities and commodities.

Last year these shares were absolute market darlings hitting their all-time high of $714.50 last December on full year earnings that came in at $15.77/share. Investors then were willing to pay over 45 times trailing earnings to participate in the future growth of this business.

Fast forward one year and now CME shares are offered at $181.90 with expected 2008 EPS of $16.47 making the current multiple a very reasonable 11.1x. Ironically, all the 'investors' who loved it at almost four times today's quote are now uninterested.

Here are the per share numbers for CME as reported by Value Line for the past six years. 2008 data includes consensus estimates for Q4 ending Dec. 31, 2008:

Year ….… Sales …… C/F ……. EPS …... Div ……. Avg. P/E

2003 …… 16.28 …… 5.32 …… 3.60 ….. 0.63 ……. 17.2x

2004 …… 21.45 …… 7.98 …… 6.38 ….. 1.04 ……. 21.3x

2005 …… 26.61 ……10.75 ……8.81 ….. 1.84 ……. 30.6x

2006 …… 31.29 ……13.78 …...11.60 …. 2.52 ……. 40.0x

2007 …… 32.96 ……14.94 …...15.77 …. 3.44 ……. 36.6x

2008 …… 42.00 ……18.01 …...16.47 …. 4.60 ……. 23.5x

The IPO for CME Group came on Dec. 6, 2002 in depressed market conditions similar to today. Buyers then paid $35 at the offering price on 2002 EPS of $3.26. That 10.74 multiple turned out to be a bargain as CME shares rocketed to $79.30 by year end 2003 and to $396.90 in less than two years. With the current valuation the lowest since that IPO I feel this is a good time to be accumulating shares.

Zacks is carrying a 2009 estimate of $17.14 which accounts for the increased number of outstanding shares due to the 'cash plus shares' deal to buy the NY Mercantile Exchange.

Even fifteen times next year's estimate would bring these shares back to $257 or plus 41% from today's quote. That's actually a very conservative 12-month target as the dead lows for these shares in 2006, 2007 and 2008 (prior to the last few months) were $354, $497, and $282 respectively.

The latest Value Line report assigned CME a financial strength rating of 'A' and gave them a 90th percentile ranking for 'earnings predictability' [100th being best].

The company is cash rich and its only long-term debt is the newly issued $1.3 billion in senior debt used to close on the NY Merc deal.

If you're still hesitant to commit you might want to try this 12.5 month combination:

………………………………………...... Cash Outlay …………. Cash Inflow

Buy 100 shares CME @ 181.90 ………. $18,190

Sell 1 Jan. 2010 $200 Call @ 38.50 …………………………….. $3,850

Sell 1 Jan. 2010 $170 Put @ 43.00 ……………………………... $4,300

Net Cash Out-of-Pocket …………………$10,040

If CME shares rise to $200 or higher (up 10% from today's price) by the expiration date of Jan. 15, 2010:

  • Your call will be exercised.
  • You will sell for $200/share and collect $20,000.
  • Your $170 put will expire worthless (a good thing for you as a seller).
  • You will have no further option obligations.

You will have $20,460 for an original cash outlay of $10,040 (including dividends of $460).

If CME shares are unchanged on expiration date in Jan. 2010:

  • Your $200 call will expire worthless.
  • Your $170 put will expire worthless.
  • You will have no further option obligations.
  • You will continue to hold 100 shares of CME worth $18,190.
  • You will have collected $460 in dividends.

You will hold stock and cash worth $18,650 for your $10,040 net cash outlay.

What's the downside risk?

If CME finished under $170/share you would be forced to buy another 100 shares for an additional $17,000 cash outlay.

Break-even on this is figured as follows:

On the original 100 shares it's your cost of $181.90 less the $38.50 call premium = $143.40/share. That's 21.16% below your purchase price.

On the $170 put it's the strike price of $170 less the $43 put premium = $127/share. That's 30.18% under your original purchase price.

The break-even point on the whole trade is the average of $143.40 and $127 = $135.20/share. That's 25.67% below your initial purchase price.

If CME shares go up, stay unchanged or even decline by as much as 25% you're in good shape.

Disclosure: Author owns shares and is short puts on CME Group.

Source: CME Group: Our Future Could Be in 'Futures'