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Sometimes opportunity presents itself in unexpected ways. Here is one of those quirky plays that seems ‘too good to be true’ but is actually available right now.

The underlying stock is Interactive Brokers Group (NASDAQ:IBKR). This is how the company describes itself:

Interactive Brokers Group is an automated global electronic market maker and broker specializing in routing orders and executing and processing trades in securities, futures and foreign exchange instruments on more than 80 electronic exchanges and trading venues around the world. As a market maker, we provide liquidity at these marketplaces and, as a broker, we provide professional traders and investors with direct access to stocks, options, futures, forex, bonds and mutual funds from a single IB Universal Account. Employing proprietary software on a global communications network, Interactive Brokers Group continuously integrates its software with a growing number of exchanges and trading venues into one automatically functioning, computerized platform that requires minimal human intervention.

I have used IBKR personally and find it the best of all the on-line brokerages. Trading costs are the lowest available, payment on free cash is higher than almost anywhere else and margin debit rates are way under those of competing firms. It offers ‘no frills’ at rock bottom prices for investors who know what they are doing and just want great executions and minimal costs.

In a time when corporate safety is paramount, IBKR stands out with over $4.4 billion in equity capital and a rock-solid balance sheet. This is IB’s 34th year of operations. They smartly took advantage of 2007’s hot market conditions to come public via a Dutch Auction on May 3, 2007 selling 40 million shares at $30.01 /share. The peak trades in 2007 and 2008 were $34.25 and $35.93 respectively giving an indication of what people will pay for this company when times are good.

After reporting somewhat disappointing earnings in for the March quarter IBKR shares tanked to an intra-day low of $13.48 on April 24th. Since then they have crept back to finish Friday at $15.45/share.

Here are the numbers for the past three years as reported in the company’s annual report. Figures for 2006 and 2007 are pro forma adjusted for the IPO in May 2007:

Year ….. Sales ….... EPS ….. B/V …..Avg. P/E ...Avg. P/ BV…52-week range
2006 …. 31.20 ….. 1.22 ….. N/A …...… N/A …...... N/A …...…... N/A
2007 …. 50.40 ….. 1.59 ….. 10.17 ….. 23.6x ….... 2.5x …….. 21.00 – 34.25
2008 …. 53.83 ….. 2.24 ….. 12.68 ….. 12.1x ….... 2.0x …….. 12.72 – 35.93

Consensus views for 2009 and 2010 center around $1.40 and $1.90 but much will depend on general market conditions. My personal view is for more a more favorable trading environment going forward.

Assuming the current estimates are correct IBKR shares now trade at just 11x this year’s and < 8.2x 2010’s projections. They’re also close to just one time book value. Last fall the company retired 65,800 shares at an average price of $13.16 with an authorization to buy back up to an additional 7.9 million shares still outstanding.

Using very conservative assumptions of a twelve multiple on earnings and a price/book value of just 1.4x I see IBKR shares hitting at least $16.80 - $19.70 by year-end 2009.

Is that crazy? No. These shares have been as high as $19.71 already this year and exceeded $34 in both 2007 and 2008.

Here’s the advertised headline play to make good returns even if these shares do absolutely nothing through this December 18th.

Buy 1000 IBKR @$15.45 ….......….. Pay $15,450
Sell 10 Dec. $15 calls @$2.35 …Collect $2,350
Sell 10 Dec. $15 puts @$1.90 … Collect $1,900
Net Cash Outlay ……............................ $11,200

If IBKR shares merely stay above $15 through Dec. 18, 2009:

  • Your $15 calls will be exercised.
  • You will sell your shares for $15,000.
  • Your $15 puts will expire worthless (a good thing for you as a seller).
  • You will have no further option obligations.

You will hold no shares and $15,000 for your original $11,200 cash outlay.

That’s a net profit of $3,800 / $11,200 = 33.9% cash-on-cash return.

The time involved in less than seven and one-half months and this best-case scenario return occurs:

  • If the shares go up
  • If the shares stay unchanged.
  • If the shares drop by $0.45 or (-2.9%) to $15.

What’s the risk?

If IBKR shares finish below $15 on Dec. 18, 2009:

  • Your $15 calls will expire worthless.
  • Your $15 puts will be exercised.
  • You will be forced to buy another 1000 shares and to lay out an additional $15,000 cash.
  • You will end up with 2000 shares of IBKR.

What’s the break-even point on the whole trade?

On the first 1000 shares it’s their $15.45 purchase price less the $2.35 /share call premium = $13.10 /share.

On the ‘put’ shares it’s the $15 strike price less the $1.90 /share put premium = $13.10 /share.

Thus, your average net cost on the 2000 shares is $13.10 /share.

IBKR could fall by as much as $2.35 or (-15.2%) from the starting price of $15.45 without causing a loss on the trade.

How can you play if you’re looking for a rise rather than just a static share price?

Buy 1000 IBKR @$15.45 …...............…. Pay $15,450
Sell 10 Dec. $17.50 calls @$1.30 …..Collect $1,300
Sell 10 Dec. $17.50 puts @$3.40 .......Collect $3,400
Net Cash Outlay …....................................…$10,750

If IBKR shares rise by $17.50 or higher [plus 13.3%] by December 18th:

  • Your $17.50 calls will be exercised.
  • You will sell your shares for $17,500.
  • Your $17.50 puts will expire worthless.
  • You will have no further options obligations.

You will hold no shares and $17,500 cash.

That’s a $6,750 profit on $10,750 or plus 62.7% best-case scenario return on shares that only had to go up by 13.3% from trade inception.

What’s the risk?

If IBKR shares are < $17.50 on Dec. 18, 2009:

  • Your $17.50 calls will expire.
  • Your $17.50 puts will be exercised.
  • You will be forced to buy another 1000 shares and to lay out an additional $17,500 cash.
  • You will end up with 2000 shares of IBKR.

What’s the break-even on the whole trade?

On the first 1000 shares it’s the $15.45 purchase price less the $1.30 /share call premium = $14.15 /share.

On the ‘put’ shares it’s the $17.50 strike price less the $3.40 /share put premium = $14.10 /share.

Your net average cost would be the average of $14.15 + $14.10 / 2 = $14.13 /share.

Even if IBKR declined by $1.32 or (-8.5%) you would not suffer a loss.

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

Source: Interactive Brokers: Making Profits on a Stock That Goes Nowhere