Only individuals who are bullish on Frontier Communications should consider employing this strategy. If you are not bullish on this stock, then it would be in your interest to look for alternative plays.
Some reasons to be bullish on Frontier Communications (FTR):
- Net income has increased from $121 million in 2009 to $150 million in 2011.
- A great dividend of 11.40.
- EBITDA has increased from $1.04 billion in 2009 to $2.3 billion in 2011.
- Sales have increased from $2.1 billion in 2009 to $5.24 billion in 2011.
- Despite its woes, it still has a positive levered free cash flow of $559 million.
- The short percentage of float is at a whopping 23.20% making it a great candidate for a short squeeze.
- A great free cash flow yield of 17%.
- There has been clustered of insider purchases in May.
(Click to enlarge)
Every attempt to put in a bottom so far has failed. However the huge surge in the short position (23.2% of the float) and the cluster of recent insider purchases could be construed as positive developments. A little good news could be the trigger needed to produce a short squeeze. A sign that a bottom is in would be either for it to close above 4 on a weekly basis or to test its recent lows but end the day on a positive note. Again this strategy is only for those who are bullish on this stock.
Sell the Jan 2014 3.00 puts for 70 cents or better. For each contract sold $70 dollars will be deposited in your account. This option has a high open interest, so you won't get killed on the spread. If you are patient you might be able to sell them for 75 cents. We are going to use this money for the second part play.
Use the proceeds from the first part to purchase the Jan 14, 5.00 calls. They are currently trading in the $0.15-0.25 ranges. These options are also very liquid and we have seen the spread narrow down to 5 cents several times, so you could get in at 20 cents or better. For this example we will assume that we are able to purchase the calls for $0.20. So with the proceeds from the first part of the transaction, you will be able to purchase 3 calls for every put sold and still have $10.00 left over. If you want to leverage the position even more, you could aim for the 5.50 calls but they are rather thinly traded and the spread is very large, so you will have to work this option a bit. We would not pay more than 15 cents per contract.
Potential risk factor
If the stock trades below 3.00 the shares could be assigned to your account, but if you are bullish on the stock that should not a big issue. Your final cost will actually be 2.90 (3.00 minus the 0.10 leftover from the premium you received. One other option would be to purchase two calls for every put sold. In this case if the shares are assigned to your account, your final cost will be 2.70 (3.00 minus 0.30). It would be wise not to get over zealous with this strategy as there is always the chance that things might not work out as planned.
Company: Frontier Communications
Levered free cash flow = $559 million
- Net Income ($mil) 12/2011 = 150
- Net Income ($mil) 12/2010 = 153
- Net Income ($mil) 12/2009 = 121
- EBITDA ($mil) 12/2011 = 2314
- EBITDA ($mil) 12/2010 = 1686
- EBITDA ($mil) 12/2009 = 1048
- Cash Flow ($/share) 12/2011 = 1.65
- Cash Flow ($/share) 12/2010 = 1.14
- Cash Flow ($/share) 12/2009 = 2.08
- Sales ($mil) 12/2011 = 5243
- Sales ($mil) 12/2010 = 3798
- Sales ($mil) 12/2009 = 2118
- Annual EPS before NRI 12/2009 = 0.55
- Annual EPS before NRI 12/2010 = 0.37
- Annual EPS before NRI 12/2011 = 0.24
- Dividend Yield = 11.40
- Dividend Yield 5 Year Average = 10.81
- Dividend 5 year Growth = -10.83
- Payout Ratio 09/2011 = 1.74
- Payout Ratio 5 Year Average 12/2011 = 1.89
- EPS Growth Quarterly(1)/Q(-3) = 116.67
- 5 Year History EPS Growth 12/2011 = -19.84
- ROE 5 Year Average 12/2011 = 21.81
- Current Ratio 12/2011 = 0.77
- Current Ratio 5 Year Average = 1.3
- Quick Ratio = 1.07
- Interest Coverage Quarterly = 1.3
This strategy provides you with the opportunity to leverage your position for free and in the process pocket $10-$30 per contract, depending on the number of calls you purchase. The risk as stated above is that the shares trade below 3.00 and the stock is assigned to your account. However, if the stock takes off you have the chance to lock in handsome gains with no out of pocket cost. The strategy is great if you are bull for the downside risk is limited, but the upside factor is technically unlimited. The huge short position and the cluster of insider purchases seem to indicate that a bottom could be close at hand. If this stock does not appeal to you, then you might find these articles to be useful Halliburton: A Potentially Great Entry Point, Or The chance to earn 8% and Showdown: General Electric Vs. Honeywell
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.
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 provided by dailyfinance.com. Option's table data and insider transactions sourced from yahoofinance.com
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.