I wrote an article on Lexmark International (LXK) at the beginning of March when the stock was trading at $36.96. There were reasons that I was bearish long term on the stock I wrote about. Its profits had dropped by 21% in the fourth quarter and the company expected revenue to decline in the first quarter also. Well I was of the opinion that the company had seen its highs for awhile. As I wrote in my reasoning behind the trade:
"We believe the stock will not rise much higher."
It turned out the judgment call on this play was good. Right after we wrote the article, little did we know, but the stock's value started to accelerate downward from there. Here is the original trade:
Option Trade
This provides us the opportunity to put together a short term options trade and position ourselves for a possible LXK correction or pullback. We like a Bear Put Spread here. Presently trading at 37.01, here is how we would initiate it:
Buy July 2012 '36' (presently priced at $2.85)
Sell July 2012 '35' (presently priced at $2.25)
Net Debit to Start: $.60
Reasoning behind the Trade
This is not the best trade when we think of profit, but knowing that the company is not expecting a stellar year, we believe the stock will not rise much higher. We also believe it will correct before mid summer as we are expecting the market to turn as a whole.
We closed out the trade and made a nice profit, much bigger than we anticipated.
- Closed out the stock at the stock is trading at 25.34 Friday.
- Sell the July 2012 put with a strike of '36' (priced at $12.70)
- Buy the July 2012 put with a strike of '35' (priced at $8.40)
- Gross Profit: (12.70 - $8.40)= $4.30
- Net Profit: [gross profit - net debit] ($4.30 - $0.60)= $3.70
- ROI: 616%
What we Learned
Obviously a profit like this is not something I come by often, and I consider it a blessing when I stumble into these. I could have taken the profit early but (fortunately) decided to let the stock continue to ride down as far as it would go. It finally looked like it hit bottom so we reversed the trade. Through this experienced I have learned that there are times that an option trader should make a judgment call to watch the slide. Since I use Bollinger Bands and it consistently road the lower band down, I knew this was a strong move. Luckily I judged this one right.
If the technical chart looks like the stock may be riding down or climbing up in strong consistent manners, let it ride until you believe the trend has ended before you get out.
(click to enlarge)
Where Is Lexmark Going?
Presently it looks like investors are not to thrilled with the company or its future prospects for success. A corporate printer service is just not working in a paperless world as old business continues to fall off the books faster than new areas of business can come one. Joe Levington, credit manager at Brookfield Investment Management summed it up when he said:
"Lexmark is in a mature-to-declining industry with a weakening position, which is pressuring profitability,"
As the company attempts to move into new markets like printing service and diversified software, the traditional business of supplies continues to undermine the attempt at new growth. Lexmark is in the midst of a strategic shift to higher usage work group printers and more profitable supplies sales. But it is subject to the economic cycles and price sensitivity. Contraction in its core business will still have a great affect upon the company's bottom line and this is predicted through this year and 2013.
Cash reserves continue to dwindle because of this. At the end of 2011 it had fallen $200 million and revenues are to continue to decline. Estimates put it at $3.91 billion through 2012 compared to $4.17 billion in 2011.
For this reason, we will not be making any short term income plays on the company for awhile and certainly would not invest in the stock long term right now or in the foreseeable future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
