A Low-Risk Naked Put Strategy For Freeport-McMoRan

| About: Freeport-McMoRan Inc. (FCX)

Selling naked puts is a great way to purchase shares in companies you like at a predetermined price. In essence, you are getting paid to wait.

An investor usually sells a put option if his/her outlook on the underlying security is bullish. The buyer of the put option pays the seller a premium for the right to sell the shares at an agreed-upon price. If the stock does not trade at or below the agreed-upon price (strike price), the seller gets to keep the premium.

Benefits associated with selling naked puts

  1. In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
  2. It allows one to generate income in a neutral or rising market.
  3. When you sell a naked put you are in a way acting like an insurance agent. The seller of the option agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, you (the seller) are paid a premium upfront. If this strategy is repeated over and over again these premiums can really help boost you returns over time.
  4. Acquiring stocks via short puts is a widely used strategy by many retail traders and is considered to be one of the most conservative option strategies. This strategy is very similar to the covered call strategy.
  5. The safest option is to make sure the put is "cash secured." This simply means that you have enough cash in the account to purchase that specific stock if it trades below the strike price. Your final price would be a tad bit lower when you add the premium you were paid up front into the equation. For example, if you sold a put at a strike of 20 with two months of time left on it for $2.50; $250 per contract would be deposited in your account.
  6. Time is on your side. Every day you profit via time decay as long as the stock price does not drop significantly. In the event it does drop below the strike you sold the put at, you get to buy a stock you like at the price you wanted. Time decay is the greatest in the front month.

The majority of traders opt to close the put out prior to expiration if they have the chance of buying it back at much lower price. For example, selling the put at $2.50 and buying it back at $0.50.

Reasons to be bullish on Freeport-McMoRan Copper & Gold Inc (NYSE:FCX):

  • A strong free levered free cash flow of $4 billion
  • Operating margins of 40%
  • A 5 year dividend growth rate of 17%
  • A decent yield of 3.10%
  • Net income increased from $2.7 billion in 2009 to $4.5 billion in 2011
  • Cash flow per share has increased from $4.44 in 2009 to $5.95 per share
  • Annual EPS before NRI has increased from $3.43 in 2008 to $4.84 in 2011
  • A high beta of 2.38 makes it a good candidate for covered writes or for selling naked puts if one is bullish on the stock
  • Year over year growth rates for 2013 is estimated to be in the 30% ranges
  • A five-year sales growth rate of 14%
  • A long-term debt to equity ratio of 0.35
  • A very strong interest coverage ratio of 21.2
  • A splendid current ratio of 3.4
  • A projected 3-5 EPS growth rate of 7%
  • A very good five-year ROE average of 32%

For those looking for more details on Freeport-McMoRan Copper & Gold they can be found in this article - Freeport McMoRan 1 Of 5 Eye Catching Plays.

Suggested naked or cash secured put strategy for FCX

The situation in Indonesia re its Grasberg mine is something that could have a negative impact on the price of this stock in the short term. We would wait for the stock to dip to 30, and that point investors can consider selling puts with strikes ranging from 25-28.

The above three-year chart illustrates that it has a very strong level of support in the 28-30 ranges. If this zone is tested it would also put in a bullish quadruple bottom formation. FCX is now trading at 32.65 so when the stock trades down to 30 we can assume that the Nov 28 puts will trade roughly at the same level the Nov 30 puts are currently trading now. The Nov 30 puts are currently trading in the 3.00-3.05 ranges with the last trade at 3.00. Let us assume that if FCX trades down to 30 that we can sell the Nov 28 puts for 3.00. Once sold $300 will be deposited in your account. If the stock does not trade below 28 you get to walk away with the premium which can be applied toward the purchase price of FCX. If it does trade below 28 you will be assigned the shares and your final cost is going to be $25.00 (28.00-3.00) which could be viewed as good long term entry price.

One option if you want to play it safe would be to place a stop at 22.85. If the stop is triggered you would be out for a break even and you could restart the process again.

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Other interesting companies

For investors looking for additional ideas, we have provided detailed data on four additional companies. An explanation on the many key ratios covered in this article can be found here - Is It Worth Getting Into Alcoa?

Company: Total SA (NYSE:TOT)

Levered Free Cash Flow = 2.46B

Growth

  1. Net Income ($mil) 12/2011 = 17523
  2. Net Income ($mil) 12/2010 = 14351
  3. Net Income ($mil) 12/2009 = 12034
  1. EBITDA ($mil) 12/2011 = 50134
  2. EBITDA ($mil) 12/2010 = 40482
  3. EBITDA ($mil) 12/2009 = 33494
  4. Cash Flow ($/share) 12/2011 = 11.51
  5. Cash Flow ($/share) 12/2010 = 11.13
  6. Cash Flow ($/share) 12/2009 = 9.3
  1. Sales ($mil) 12/2011 = 245420
  2. Sales ($mil) 12/2010 = 217573
  3. Sales ($mil) 12/2009 = 183201
  1. Anl EPS before NRI 12/2009 = 4.85
  2. Anl EPS before NRI 12/2010 = 6.26
  3. Anl EPS before NRI 12/2011 = 6.72

Dividend history

  1. Dividend Yield = 5.9
  2. Dividend Yield 5 Yr Average = 4.8
  3. Dividend 5yr Growth 12/2011 = 5.14%

Dividend sustainability

  1. Payout Ratio 09/2011 = 0.47
  2. Payout Ratio 06/2011 = 0.39
  3. Payout Ratio 5 Yr Average 12/2011 = 0.43
  4. Change in Payout Ratio = -0.06

Performance

  1. 5 Yr Historical EPS Growth 12/2011 = -5.66
  2. ROE 5 Yr Average 12/2011 = 23.71
  3. Current Ratio 12/2011 = 1.36
  4. Current Ratio 09/2011 = 1.4
  5. Quick Ratio = 0.98
  6. Cash Ratio = 0.55
  7. Interest Coverage 12/2011 = 36.83

Company: MasterCard Inc (NYSE:MA)

Basic Key ratios

Percentage Held by Insiders = 0.15

Number of Institutional Sellers 12 Weeks = 3

Growth

  1. Net Income ($mil) 12/2011 = 1906
  2. Net Income ($mil) 12/2010 = 1846
  3. Net Income ($mil) 12/2009 = 1463
  1. EBITDA ($mil) 12/2011 = 2970
  2. EBITDA ($mil) 12/2010 = 2992
  3. EBITDA ($mil) 12/2009 = 2560
  1. Cash Flow ($/share) 12/2011 = 20.49
  2. Cash Flow ($/share) 12/2010 = 15.5
  3. Cash Flow ($/share) 12/2009 = 13.24
  1. Sales ($mil) 12/2011 = 6714
  2. Sales ($mil) 12/2010 = 5539
  3. Sales ($mil) 12/2009 = 5099
  1. Annual EPS before NRI 12/2007 = 5.7
  2. Annual EPS before NRI 12/2008 = 9.04
  3. Annual EPS before NRI 12/2009 = 11.38
  4. Annual EPS before NRI 12/2010 = 14.05
  5. Annual EPS before NRI 12/2011 = 18.7

Dividend history

  1. Dividend Yield = 0.3
  2. Dividend Yield 5 Year Average =0.3
  3. Forward Yield = 0.3
  4. Dividend 5 year Growth =32%

Dividend sustainability

  1. Payout Ratio = 0.04

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 60.35
  2. Next 3-5 Year Estimate EPS Growth rate = 15.57
  3. EPS Growth Quarterly(1)/Q(-3) = 106.06
  4. ROE 5 Year Average 12/2011 = 42.51
  5. Return on Investment 06/2011 = 42.61
  6. Debt/Total Cap 5 Year Average 06/2011 = 2.08
  1. Current Ratio 06/2011 = 1.84
  2. Current Ratio 5 Year Average = 1.85
  3. Quick Ratio = 1.84
  4. Cash Ratio = 1.64
  5. Interest Coverage Quarterly = N/A

Company: Bristol-Myers (NYSE:BMY)

Levered Free Cash Flow = $5.16B

Basic Key ratios

  1. Percentage Held by Insiders = 0.64
  2. Market Cap ($mil) = 56819

Growth

  1. Net Income ($mil) 12/2011 = 3709
  2. Net Income ($mil) 12/2010 = 3102
  3. Net Income ($mil) 12/2009 = 10612
  1. EBITDA ($mil) 12/2011 = 7782
  2. EBITDA ($mil) 12/2010 = 6815
  3. EBITDA ($mil) 12/2009 = 6309
  4. Cash Flow ($/share) 12/2011 = 2.79
  5. Cash Flow ($/share) 12/2010 = 2.61
  6. Cash Flow ($/share) 12/2009 = 2.21
  1. Sales ($mil) 12/2011 = 21244
  2. Sales ($mil) 12/2010 = 19484
  3. Sales ($mil) 12/2009 = 18808
  1. Annual EPS before NRI 12/2009 = 1.85
  2. Annual EPS before NRI 12/2010 = 2.16
  3. Annual EPS before NRI 12/2011 = 2.28

Dividend history

  1. Dividend Yield = 4.10
  2. Dividend Yield 5 Year Average =4.61%
  3. Annual Dividend 12/2011 = 1.32
  4. Annual Dividend 12/2010 = 0.96
  5. Forward Yield = 4.04
  6. Dividend 5 year Growth = 0.41%

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.58
  2. Payout Ratio 5 Year Average 06/2011 = 0.7
  3. Change in Payout Ratio = -0.12

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 20.21
  2. Next 3-5 Year Estimate EPS Growth rate = 1.67
  3. EPS Growth Quarterly(1)/Q(-3) = -112.77
  4. ROE 5 Year Average 06/2011 = 26.33
  5. Return on Investment 06/2011 = 18.29
  6. Debt/Total Cap 5 Year Average 06/2011 = 30.31
  1. Current Ratio 06/2011 = 1.97
  2. Current Ratio 5 Year Average = 1.9
  3. Quick Ratio = 1.79
  4. Cash Ratio = 1.31
  5. Interest Coverage = 49

Company: Chevron Corp (NYSE:CVX)

Growth

  1. Net Income ($mil) 12/2011 = 26895
  2. Net Income ($mil) 12/2010 = 19024
  3. Net Income ($mil) 12/2009 = 10483
  1. EBITDA ($mil) 12/2011 = 60545
  2. EBITDA ($mil) 12/2010 = 45168
  3. EBITDA ($mil) 12/2009 = 30666
  4. Cash Flow ($/share) 12/2011 = 19.99
  5. Cash Flow ($/share) 12/2010 = 15.91
  6. Cash Flow ($/share) 12/2009 = 10.86
  1. Sales ($mil) 12/2011 = 253706
  2. Sales ($mil) 12/2010 = 204928
  3. Sales ($mil) 12/2009 = 171636
  1. Annual EPS before NRI 12/2007 = 8.63
  2. Annual EPS before NRI 12/2008 = 11.38
  3. Annual EPS before NRI 12/2009 = 4.84
  4. Annual EPS before NRI 12/2010 = 9.45
  5. Annual EPS before NRI 12/2011 = 13.44

Dividend history

  1. Dividend Yield = 3.5
  2. Dividend Yield 5 Year Average 12/2011 = 3.23
  3. Dividend 5 year Growth 12/2011 = 7.4

Dividend sustainability

  1. Payout Ratio 09/2011 = 0.24
  2. Payout Ratio 5 Year Average 12/2011 = 0.31

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 2.15
  2. 5 Year History EPS Growth 12/2011 = 6.98
  3. ROE 5 Year Average 12/2011 = 21.14
  4. Return on Investment 12/2011 = 20.71
  5. Current Ratio 12/2011 = 1.61
  6. Current Ratio 09/2011 = 1.61
  7. Current Ratio 06/2011 = 1.58
  8. Current Ratio 5 Year Average = 1.42
  9. Quick Ratio = 1.42
  10. Cash Ratio = 0.77
  11. Interest Coverage Quarterly = N/A

Valuation

  1. Book Value Quarterly = 63.9
  2. Price/ Book = 1.61
  3. Price/ Cash Flow = 5.14
  4. Price/ Sales = 0.8
  5. EV/EBITDA 12 Mo = 3.17

Conclusion

The markets are oversold on a short-term basis, and it would not surprise us if they mounted some sort of relief rally before trending downwards again. Long-term investors can use strong pullbacks to slowly start deploying money into long-term investments. A great way to get into a stock at a price of your choosing is to sell puts at strikes you would not mind owning the stock at. Investors looking for other investment ideas might find these two articles to be of interest: Is It Worth Getting Into Alcoa? and General Electric Among 2 Attractive Dividend And 3 growth plays.

Disclaimer

This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Earnings and growth estimate data sourced from dailyfinance.com Option table sourced from yahoo finance.