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.
