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

InterContinentalExchange [NYSE:ICE - $100.16] is among the world’s largest derivative exchange groups and over-the-counter markets. They provide energy, soft commodities, and financial trading products. ICE serves the risk-management, asset-allocation, and speculative needs of financial institutions, investors, and commercial companies.

ICE was formed in 2000 and came public on November 21, 2005. Sales and earnings have grown substantially since their IPO. EPS are expected to have hit record levels of about $4.53 in 2009 and to grow further – to about $5.23 in 2010.

Here are their per share numbers as reported by Value Line:

Year

Sales

C/F

EPS

B/V

Avg. P/E

52-wk. range

2005

2.81

1.21

d. 0.21

4.19

NMF

31.30 – 44.20

2006

5.40

2.70

2.40

7.82

28.8x

35.40 – 113.90

2007

8.24

3.92

3.39

21.19

43.9x

108.10 – 194.90

2008

11.24

5.02

4.33

27.72

26.6x

49.70 – 193.90

2009*

13.30

5.35

4.53

31.08

20.5x

50.10 – 121.93

* 2009 data includes Q4 consensus estimates

The worldwide market for futures, commodity and credit derivatives appears to be in an expansion mode which bodes well for ICE. The shares are not cheap at 22.1x last year’s and about 19.2x expected 2010 earnings- but they are now well under their historical multiples as can be seen from the chart above.

The balance sheet is rock solid. Treasury cash of over $393 million exceeded total debt of $330 million as of September 30, 2009. Total interest coverage is running a very healthy 25x. There is no defined benefit pension plan and capital spending needs are minimal.

Value Line is using a 25 multiple in figuring their 3- 5 year target pricing for ICE. I’m going even more conservative and only assuming a 22.5x P/E. That would bring ICE shares back to > $117 by year end if the consensus estimate is accurate.

ICE shares are down from about $113 to start this month and market VIX has increased due to the three-day, 553-point drop in the DJIA. I’m using those two factors to put on a two-year trade that offers good upside with only moderate risk.

Here’s my trade:

Cash Outlay

Cash Inflow

Buy 100 ICE @ $100.16 /share

$10,016

Sell 1 Jan. 2012 $110 call @ $17 /share

$1,700

Sell 1 Jan. 2012 $110 put @ $25 /share

$2,500

Net Cash Out-of-Pocket

$5,816

If ICE merely rebounds to $110 or better [+10%] by the Jan. 2012 expiration date:

  • The $110 call will be exercised.
  • You will sell your shares for $11,000.
  • The $110 put will expire worthless.
  • You will be left with no shares and $11,000 in cash.
  • You will have no options obligations.

That would represent a best-case scenario profit of $5,184/$5,816 = + 89% cash-on-cash achieved over < 24 months on shares that only needed to rise by 10%.

If ICE remains < $110 on the Jan. 2012 expiration date:

  • The $110 call will expire worthless.
  • The $110 put will be exercised.
  • You will be forced to buy another 100 shares of ICE.
  • You will need to lay out an additional $11,000 in cash.
  • You will end up with 200 ICE shares.
  • You will have no further option obligations.

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

On the original 100 shares it’s the $100.16 purchase price less the $17 /share call premium = $83.16 /share.

On the ‘put’ shares it’s the $110 strike price less the $25 /share put premium = $85 /share.

Your overall break-even would be $84.08 /share or (-16%) from yesterday’s closing trade.

Summary:

The buy/write combination described would lever any gain of 10% or greater over the two-year period to January of 2012 into an 89% total return.

You have a built-in 16% margin of safety as ICE shares would have to fall below $84.10 /share on the trade’s expiration date before any loss would occur.

NOTE: I had written up a similar buy/write combination on ICE last April 23rd using the January 2010 expiration date and the $80 calls and puts. That trade worked out very well with a 64% cash-on-cash return over the 9-month holding period.

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

Source: InterContinentalExchange for Future Profits