3 Undervalued Stocks and How to Profit From Them Using Targeted Options Strategies

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Includes: AET, OMN, PCLN
by: Simon Monger
Coventry Health Care Inc. (CVH), Priceline.com Inc. (NASDAQ:PCLN) and OMNOVA Solutions Inc. (NYSE:OMN) are three potentially-undervalued stocks that could see a strong turnaround over the coming months. In this article, we’ll take a look at these three opportunities and how to use targeted options strategies to profit from each unique situation.
Coventry: Sell-Off Creates Even Deeper Discount
Coventry Health Care Inc. (CVH), a diversified national managed healthcare company, fell sharply last week after providing an outlook for FY2011 that was below analyst estimates. The company sees its FY2011 EPS at between $2.65-2.85, compared to a consensus of $2.85, while it sees revenues of between $11.675-$12.095 billion, compared to a consensus of $12.13 billion.
Despite the downward pressure, analysts at Credit Suisse attributed the sell-off to a misinterpretation of management comments on pricing, and recommended buying the shares on the weakness. The analysts further noted that the company will make accretive acquisitions or buy back shares and even views it as a potential takeover target with an Outperform rating and price target of $37.00 per share.
Investors that share these sentiments may want to consider purchasing a bull call spread on the stock with a $40.00 price target. Using medium-term October 2011 options, the bull call spread could be created by purchasing a 33 October 11 call for $3.10 and writing a 40 October 11 call for $0.55 for a net credit of $2.55 per contract. If the underlying hits $40.00, the position would yield a profit of around $4.45 per contract, while the downside is limited to the $2.55 per contract paid.
Priceline.com: Cautiously Optimistic on Q2 Results
Priceline.com Inc. (PCLN), a global online travel company offering a wide range of services, could exceed the high end of its guidance, according to ThinkEquity. The analyst believes that the firm can surpass analyst estimates during the second quarter and reiterated its Buy rating and $630.00 per share price target. As a result, this may be another stock to consider playing going into its earnings results.
Despite the optimism, there is also some risk that travel may begin to slow down with higher oil prices. The increased cost of oil will eventually lead to higher airfare prices, as jet fuel is one of the largest expenses for airlines, and higher fares may mean less travel. Consequently, investors may also want to exercise a bit of caution, as the firm’s future outlook may be weaker-than-expected.
Investors looking for a cautious play just on earnings results may want to consider simply betting on volatility instead of direction using a long straddle. Using short-term June 2011 options, investors can create a long straddle by purchasing one at-the-money 550 June 11 call for $35.95 and purchasing another at-the-money 550 June 11 put for $28.00. If the underlying moves in either direction beyond the net debit of $63.95, you are in-the-money by that amount.
OMNOVA: An Undervalued Play on Construction
OMNOVA Solutions Inc. (OMN), a provider of emulsion polymers, specialty chemicals and other surfaces for the construction industry, appears to be undervalued and may be a solid play on the recovery in the construction industry, according to analysts at Jeffries. The analyst upgraded the stock to a Buy with an $11.00 per share price target, which led to a sharp jump during today’s session.
Currently, the company trades for just 4.13x its trailing 12-month earnings with a market capitalization of $418.45 million. Meanwhile, the construction industry appears on track for a recovery with the Commerce Department’s most recent data pointing to a better-than-expected rise in March; spending increased 1.4% to an annual rate of $768.9 billion, reflecting strong gains in residential and commercial.
Investors looking to play this broad recovery in construction and a possible return to fair valuation for the stock may want to consider simply purchasing longer-term call options. Currently, the company has November 2011 call’s trading with a $10.00 strike for just $0.90 per contract. As a result, investors can gain the exposure for 100 shares for just $90.00, and with just $90.00 in total downside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.