Nasdaq OMX Group: You Can't Beat the Dealer

This company operates the largest electronic securities market in the United States [the NASDAQ] and has international exposure through its acquisition of the Nordic exchange [the OMX AB] and their one-third interest in DIFX – an international financial exchange headquartered in Dubai. Purchases of both the Philadelphia and Boston Stock Exchanges are now pending and will give NDAQ significant options trading capabilities.

The purchase of the Philly and Boston exchanges has already been financed with issuance of $425 million of 2.5% coupon bonds due in 2013 convertible into 18.1386 shares per $1000 face. That's a conversion value of $55.13/share.

NASDAQ was the world's first all-electronic market and came public in July of 2002. Revenues and earnings have been growing nicely since 2004 and 2008 looks to be well on the way to new records in both categories.

Here are the per-share numbers from 2004 – 2007:

March quarter profits were $0.48 versus $0.29 year-over-year and analyst estimates for 2008 and 2009 now run about $1.94 /share and $2.46 /share respectively.

The recent share price drop makes NDAQ's multiple just 17.2x this year's and 13.6x next year's projections. That's very low compared to these shares past trading history. Value Line is assuming a P/E of 20 in figuring their 3 – 5 year target price range of $60 – $95.

That 20 multiple leads me to a $38.80 goal by year-end 2008 and almost $50 by the close of 2009. That YE 2009 target is 50% higher than today's quote.
 
Are those numbers achievable? They may well be too conservative. Nasdaq OMX shares actually peaked at $45.20 - $50.50 in each of the years 2005-2006-2007 and touched $49.90 in January this year.

NDAQ is a high Beta stock. As such, using options presents some tremendous opportunities to make above average gains without undue risk.

Here are three potential combination plays that make sense to me. In each case I'll use 1000 share examples for convenience.

In NDAQ shares are above $35 (up 5.1% from your purchase price) on expiration date [Jan. 20, 2009]:

Your shares will be called [sold] for $35,000.

The $35 puts will expire worthless [a good thing for you- the seller].

You will hold no shares, no options and $35,000 cash.

That is a profit of $10,880 on a cash outlay of $24,120.

That's + 45.1% (cash-on-cash) over the 8 months of the trade.

Break-even on this whole trade is $29.50 /share.

Here's the same combo but with a January 2010 set of options:

In NDAQ shares are above $35 (up 5.1% from your purchase price) on expiration date [Jan. 2010]:

Your shares will be called [sold] for $35,000.

The $35 puts will expire worthless [a good thing for you- the seller].

You will hold no shares, no options and $35,000 cash.

That is a profit of $16,280 on a cash outlay of $18,720.

That's + 86.9% profit (cash-on-cash) over the 20 months of the trade.

Break-even on this whole trade is $26.80 /share.

Here's the more aggressive combo, also out to January 2010:

In NDAQ shares are above $40 (up 20.1% from your purchase price) on expiration date [Jan. 2010]:

Your shares will be called [sold] for $40,000.

The $40 puts will expire worthless [a good thing for you- the seller].

You will hold no shares, no options and $40,000 cash.

That is a profit of $22,600 on a cash outlay of $17,400.

That's + 129.88% profit (cash-on-cash) over the 20 months of the trade.

Break-even on this whole trade is $28.70 /share.

Options involve risk and should only be traded by investors who understand their intricacies. In each example shown above the worst-case scenario would require the option seller to own twice their original number of shares of NDAQ at a net purchase price equal to the break-even share price shown in each example.

Disclosure: Author owns shares and is short options on NDAQ.

Comments

[Paul Price:]

There was a small error in the last example.

The correct out-of-pocket number should read: $17,520, the net profit if shares > $40 would be $22,480 and the cash-on-cash best case profit would be 128.3%.

The top two examples read correctly.

2008 May 28 12:44 PM