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Nasdaq OMX owns and operates the largest electronic securities market in the United States as well as the Nordic exchange OMX and the Philadelphia Exchange which trades stocks and options.

Despite recent market conditions 2008 saw all-time record earnings per share at $2.01 versus $1.59 in 2007. Revenues grew to $3.649 billion from $2.437 billion but that includes revenues from their recently completed acquisitions so it is not apples to apples on a year over year basis.

Because of the dull trading environment consensus views for 2009 and 2010 are now subdued at $2.03 and $2.30 respectively. Should the markets show a decent rebound it would be expected that these estimates would rapidly adjust considerably higher.

Even using the current estimate of $2.03 these shares are now offered at just 10.2x this year’s earnings. That’s the lowest valuation for these shares ever excepting when they hit their panic lows last November. NDAQ shares hit yearly peaks of $45.20 - $50.50 in each calendar year from 2005 through 2008 giving you an indication of where they can trade when the market mood is brighter.

Here are the per share numbers since 2005 as reported by Value Line:

Year …… Rev .…....... C/F …. EPS …...B/V ….. Avg. P/E

2005 ……10.58 …..... 1.51 …. 0.57 .….. 1.90 …... 36.1x

2006 ……14.76 ....…. 1.51 …. 0.75 …. 12.98 …... 45.9x

2007 ……17.55 …..... 1.95 …. 1.59 …. 15.90 ...… 22.1x

2008 ……18.10 …..... 2.60 …. 2.01 …. 13.20 ...… 16.1x

Book Value growth was erratic due to secondary offerings of shares used to finance acquisitions (although they were anti-dilutive to B/V).

As you can see from the data the current P/E, P/CF, P/S and P/BV are all at extremely cheap levels compared with all prior history. Value Line is assuming a bounce back to an 18 multiple in making their 3 – 5 year projections. Even a 15 P/E on this year’s estimate would bring these shares back to $30.45 or about 47% above today’s quote.

I think market conditions and profits will be much higher by 2011 so I’m using a long term buy and write combination to lock in great volatility premiums while giving myself plenty of time for things to recover.

I’ve already made the case that these shares could be $30 + well before the end of 2010 so I’m taking an aggressive stance here today.

Here’s my best play on Nasdaq OMX:

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

Buy 1000 NDAQ @ $20.67 …….......…… $20,670

Sell 10 Jan. 2011 $30 calls @ $4.20 ….............………………….… $4,200

Sell 10 Jan. 2011 $30 puts @ $12.90 ……...........…;……..……… $12,900

Net Cash Out-of-Pocket ……...............… $3,570

On expiration date in January 2011:

If NDAQ shares are $30 or higher [up 45% from our starting price]:

  • Your $30 calls will be exercised.
  • Your shares will be sold for $30,000.
  • Your $30 puts will expire worthless (a good thing for you as a seller).
  • You will have no further option obligations.

You will hold $30,000 cash for an original outlay of just $3,570 for a best case scenario total return of 740% [$30000 - $3570 = $26,430 profit].

What’s the static return if the shares stay exactly unchanged?

  • Your $30 calls would expire worthless.
  • Your $30 puts would be exercised.
  • You would be forced to buy an additional 1000 shares and to layout another $30,000 cash.
  • You would now own 2000 shares of NDAQ.

Your total start-to-finish net break-even for these shares would be figured as follows:

On the first 1000 shares it’s the $20.67 /share cost less the $4.20 /share call premium = $16.47 /share.

On the second 1000 shares it’s the $30 strike price less the $12.90 /share put premium = $17.10 /share.

Your net break even point would be the average of those two prices.

$16.47 + $17.10 divided by 2 = $16.79 /share

If NDAQ shares were unchanged from your starting price of $20.67 you would own 2000 shares @ $20.67 = $41,340 worth of stock while your total outlay was only the original $3,570 plus the later outlay of $30,000.

Here’s the final math:

Total Value of 2000 shares @ $20.67 …………….. $41,340

Total Cash Outlay for 2000 shares ………...……… $35,700

Net Profit on an unchanged stock price ……………. $5,640

Even assuming you had laid out the entire $35,700 from day one that’s a 15.8% total return for less than 22 months or about 8.6% annualized.

Your margin of safety is the $3.88 /share difference between the average net cost of $16.79 and the original starting price of $20.67. Thus, even if NDAQ shares declined by up to 18.7% you would not lose money on this trade.

Nasdaq OMX shares did not trade below $20 for even one day between late 2005 and October of 2008. During that three year period EPS surged from $0.57 to $2.01 and Book Value climbed from $1.90 to $13.20.

Unless you’re quite bearish over the next couple of years this trade seems to make good sense with huge upside balanced against moderate potential losses.

Disclosure: Author is long NDAQ shares and short NDAQ options.

Source: NASDAQ OMX Group: A Levered Play on a Market Recovery