Options Trades To Profit From Ford's Comeback

Jan. 5.12 | About: Ford Motor (F)

It is no surprise that American automakers are back with a vengeance. After almost 30 years of losing market share to their Japanese, German, and Korean rivals they are finally beginning to gain some of it back. American manufacturers -- in particular Ford Motor Company (NYSE:F) -- are coming out with fresh, innovative designs with increased technology and build quality at many times more competitive prices than rivals Toyota Motor Corporation (NYSE:TM) or Honda Motor Co. (NYSE:HMC).

Not only are Japanese manufacturers suffering from supply chain disruption due to the earthquake, but their products are facing greater resistance from American consumers. A prime example of this is the new Honda Civic. The Civic, normally the bread and butter of the small car segment, is facing stagnant sales, forcing Honda to release a new model for 2013. Consumers complained of low-quality interiors, bland styling, and the car's "light" feeling when driving.

Contrary to the struggles of the Japanese manufacturers, Ford is thriving, with sales up 17% in 2011. Lead by small cars like the Fiesta and Focus and further aided by the F-Series trucks and Escape SUV. Ford has a big 2012 ahead; automotive experts are predicting even greater sales in 2012 due to an aging auto fleet in need of replacement. The average age of vehicles on the road today is 10.9 years; historically this number is usually closer to 6 years. Additionally, Ford will be releasing updated 2013 model vehicles featuring greater fuel efficiency and more standard tech features due to a partnership with Microsoft Corporation (NASDAQ:MSFT).

Ford is under excellent leadership. CEO Alan Mulally rescued the company in 2007 and promised to restore founder Henry Ford’s vision for the company. He has done just that through his restructuring plan. Unlike its competitors, Ford was the only Big Three Detroit automaker (Ford, General Motors (NYSE:GM), and Chrysler Fiat SPA Ads (FIATY.PK) to not seek government assistance. Along with this restructuring came a large amount of debt, but now that Ford is profitable, ratings agencies have promised to raise Ford's debt ratings to investment-grade which will lead to less credit expense and greater profit. Last Ford signaled to investors its growing strength by reinstating a dividend, a sign that ford is confident in its future.

I think that Ford is going to be a great play in 2012. I also feel it will be advantageous to use derivatives as a hedge. My trade on Ford goes as follows:

Buy shares of Ford at market price

Sell Jan 13 strike $12.5 calls at price of $1.15

for a cost of approximately $10.15

Selling the Jan 13 strike $12.5 calls allows the investor to achieve a return of 23%, while at the same time providing some cushion on the downside, as losses are not realized until Ford hits $10.15, which is down close to 10% from its closing price today.

A more risk-tolerant investor may also benefit from selling puts; although risky, it may prove to be quite beneficial if executed properly. A trade that strikes me as quite attractive is the sale of Jan 13 strike $10 puts for ($1.16). For a loss to be realized to the selling party, the stock would need to go down to $9.14, a move down of a little over 18%. If at the date of option expiration Ford remains above $10, the investor would be able to keep the entire $1.16. Theoretically, the seller of out-of-the-money puts is more likely to be profitable than the buyer, because even if the stock does not move, the seller is still making money -- the puts sold are constantly decreasing in value as time goes on. Remember, over 75% of puts sold expire worthless at the date of expiration.

Additionally, Ford is expected to earn $1.87 which, will be added to the equity of the stock, so in actuality for Ford to hit $9.14 (the point at which the seller of strike $10 puts loses money), the share price would have to be 35% cheaper than it stands today. To sell the Jan 13 strike $10 puts, my broker requires $5 of capital for each contract sold as a margin of safety. So as long as Ford stays above $10, the seller of the put achieves a 23.2% rate of return.

Disclosure: I am long F.