Seeking Alpha
Value, growth at reasonable price, contrarian, newsletter provider
Profile| Send Message|
( followers)  

I wrote positively about Knight Capital Group (NITE) here back on April 21, 2009 after the shares had closed at $14.84. With the market recovery and good second quarter earnings, NITE has risen to $18.15 /share. It still presents good opportunity from today’s level for those sophisticated enough to augment their stock purchase with the sale of options.

Knight Capital Group (NDQ:NITE) August 12, 2009 close: $18.15

52-week range: $11.03 (Oct. 10, 2008) - $19.98 (Feb. 9, 2009)

Knight is the largest wholesale market making firm in U.S. equity securities. They execute transactions for institutional customers as well as broker-dealers. NITE also actively trades for its own account.

Second quarter earnings from continuing operations came in at a better than expected $0.52 versus $0.32 and NITE shares trade nearer their 52-week high than their low. The valuation, however, still looks relatively cheap.

Here are the per share numbers from continuing operations as reported by Value Line:

Year

Sales

C/F

EPS

B/V

Avg. P/E

2003

5.82

0.85

0.59

6.86

14.4x

2004

5.71

0.51

0.36

7.79

31.3x

2005

5.57

0.51

0.34

7.93

26.5x

2006

9.18

1.73

1.49

9.29

10.5x

2007

9.89

1.59

1.24

9.67

12.4x

2008

11.46

2.28

1.94

11.40

8.4x

As with all market-related companies, earnings predictability is not easy. Zacks now carries 2009 – 2010 estimates (on cont. ops.) of $1.61 and $1.72 while S&P is looking for $1.78 and $1.99 respectively.

Even at the lower end that makes NITE’s multiple < 11.3x this year’s and under 10.6x next year’s projections. The balance sheet is very healthy with total debt of $140 mm against about $364 mm in cash and short-term securities. Debt/equity is under 12%.

S&P rates NITE as 4-Stars (out of 5) and sees a 12 month price target of $22. Morningstar has NITE’s ‘fair value’ pegged at $21 /share.

Here are two buy/write plays that could capture very nice total returns even if NITE shares don’t do a whole lot over the next 17 – 18 months.

For conservative investors that would be satisfied with just over 20% annualized:

Cash Outlay

Cash Inflow

Buy 1000 NITE @$18.15

$18,150

Sell 10 Jan. 2011 $17.50 Calls @$3.80

$3,800

Sell 10 Jan. 2011 $17.50 Puts @$3.00

$3,000

Net Cash Out-of-Pocket

$13,350

If NITE shares merely stay about $17.50 through the Jan. 2011 expiration:

  • The $17.50 calls will be exercised.
  • You will sell your shares for $17,500.
  • The $17.50 puts will expire worthless.
  • You will have no further option obligations.
  • You will hold no shares and $17,500 in cash.

That’s a best-case scenario net profit of $4,150 /$13,350 = 31.1% achieved in 1.43 years on shares that:

  • Went up.
  • Stayed unchanged.
  • Declined by up to 3.5% (to $17.50).

Break-even on this trade is $14.43 /share or 20.5% below your starting price.

For slightly more aggressive investors (that can see NITE rising to at least $20) by January 2011:

Cash Outlay

Cash Inflow

Buy 1000 NITE @$18.15

$18,150

Sell 10 Jan. 2011 $20 Calls @$2.50

$2,500

Sell 10 Jan. 2011 $20 Puts @$4.10

$4,100

Net Cash out-of-Pocket

$11,550

If NITE finishes above $20 on the Jan. 2011 expiration date:

  • The $20 calls will be exercised.
  • You will sell your shares for $20,000.
  • The $20 puts will expire worthless.
  • You will have no further option obligations.
  • You will end up with no shares and $20,000 in cash.

That’s a best-case scenario net profit of $8,450 / $11,550 = 73.1% achieved on shares that only needed to go up by 10.2% from the trade’s inception price.

Break-even on this, more aggressive, trade is calculated as follows.

On the original 1000 shares it’s their $18.15 purchase price less the $2.50 /share cal premium = $15.65 /share.

On the ‘put’ shares [assuming exercise] it’s the $20 strike price less the $4.10 /share put premium = $15.90 /share.

Your overall break-even would be $15.78 /share.

NITE could fall by as much as 13% without causing a loss on this trade.

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

Source: Knight Capital Could Make Your Day