This strategy not only provides one with the chance to leverage one's position in Duke Energy (DUK) but it always provides one with the chance to get into the stock at a much lower price. This technique should only be employed if you are bullish on the stock. If you are not bullish on the long term prospects of this stock, then you would be better served by looking for other plays.
Reasons to like Duke Energy:
- Its merger with Progress Energy, Inc, is expected to be a good fit and boost earnings. The combined assets of the two companies would make it the largest U.S. utility providing services to more than 7.1 million customers. The merger is expected to go through by July 8, 2012 and would enable the company to maintain its long-term goal of 4.5%-6% earnings growth.
- It has a strong balance sheet with a low long-term debt to capitalization ratio of 44% at the end of fiscal 2011. It closed 2011 with a cash and cash equivalents of $2.1 billion.
- A strong relative strength score of 82 out of a possible 100.
- A 5 year dividend average of 5.3%.
- Net income increased from $1.07 billion in 2009 to $1.7 billion in 2011.
- A good free cash flow yield of 6.3%.
- A low beta of 0.18 indicates that it's not a volatile stock.
- Cash flow increased from $2.68 in 2009 to $2.98 in 2011.
- Annual EPS before NRI increased from $1.25 in 2007 to $1.46 in 2011.
- A projected 3-5 year EPS growth rate of 4.3%
- $100K invested for 10 years would have grown to $165K. If the dividends were reinvested the rate of return would have been much higher.
- While the rest of the market has been tanking this stock has actually been soaring to new highs.
Suggested strategy for Duke Energy
After putting in a series of new 52-week highs, the odds favor some sort of consolidation and there is good chance it could pull back to the 21-22 ranges before trending higher.
The Jan 2013 22.50 puts are trading in the $0.75-0.85 ranges. If the stock pulls back to the above stated ranges these puts should trade in the 1.10-1.30 ranges if not higher. For this example we will assume that the puts can be sold for 1.10 if the stock trades in the above stated ranges. Those who are bullish right now can sell the puts for 80 cents or better.
The Jan 2013, 24 calls are trading in the 35-45 cent ranges. If the stock pulls back to the 21-22 ranges, these options should trade roughly in the same ranges the Jan 2013, 25 calls are currently trading at ($01.5-$0.20). For this example, we will assume that the calls be can be purchased for $0.20. With the proceeds from part 1, you will be able to purchase up to five calls and still have $10 left over per transaction. For those who are bullish on the stock at current prices and sold puts at 80 cents or better. You could purchase the Jan 2013 25 calls for 20 cents or better. You will still be able to leverage your position considerably as you will be able to purchase 4 calls for each put sold.
You have the opportunity to significantly leverage your position with no out of pocket cost. If the stock trades below the strike price you sold the puts at you have a chance of getting into the stock at a price of your choosing.
The risk factor is that you have a change of heart and feel that the stock could trade significantly below the strike you sold the puts at. In this case, the solution is to roll over the puts. You purchase the ones you sold and sell new puts that are slightly out of the money. You should only implement this strategy if you are bullish on the stock.
Only put this strategy to play if your outlook on this stock is bullish. In general the best way to get into a stock at a price of your choosing is to sell puts on it. Investors looking for other ideas might find this article to be of interest - Southern Company: A Top Play In The Utility Sector.
It is imperative that you do your due diligence and then determine if the above strategy meets 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. Options tables sourced from money.msn.com. Earnings and growth estimates sourced from dailyfinance.com.