'Take Off' with Boeing Option Combination Plays

Concern about delivery delays in Boeing's (BA) newest 787 Dreamliner has hurt BA shares. The stock has come down 27.5% from its July 2007 high, despite the fact that last year's earnings were $5.26 – the highest ever.

After processing the latest news 2008 and 2009, estimates now center around $5.96 and $6.80 meaning BA shares are trading at just 13.1 times this year's and 11.5x 2009 projections. Value Line sees 3- 5 year EPS of $9.00 once the new Dreamliner aircraft is fully in delivery mode.

Boeing's 10-year median P/E has been 21 but with cyclical stocks you need to adjust for 'normalized' earnings power rather than just look at current year earnings. Value Line sees a long term multiple of 15 as typical. I think that's reasonable for Boeing based on sustainable earnings power.

Fifteen times this year's estimate of $5.96 would bring BA shares back to $89.40 by year end and to $102 by December 2009. Here are the per share numbers* from the past five years.

Year…..….Sales……Cash Flow……..EPS……. idend.....Avg. Yield

2007….…$90.12…..…$7.53………..$5.26……..$1.45……….1.5%

2006….…$81.19…..…$5.78………..$5.78……..$1.25……….1.6%

2005….…$72.11…..…$4.50………..$2.39……..$1.05……….1.7%

2004…….$66.13……..$3.57………..$1.63……..$0.85……….1.8%

2003…….$63.08……..$2.82………..$1.00……..$0.65……….2.0%

*Source: Value Line

Buyers at last year's peak price of $107.80 were too enthusiastic with future prospects and overpaid at 20.5x full year 2007 EPS. Today you can own these same shares for just 13.1x current year estimates.

Value Line rates Boeing's financial strength at 'A++' and gives them a #1 rating [their highest] for Safety. Government subsidized Airbus is the only true competitor large enough to ever threaten Boeing's place in the commercial airline business. There clearly seems to be room for both, yet huge barriers to entry for any new producers.

If Boeing shares hit my year-end 2009 target of $102 we'll see capital gains of 30.5% on top of the 3.1% yield over those 19 months. A 33.6% total return potential on these high quality shares looks attractive to me as it annualizes at about 21%.

For option savvy investors here are two relatively low-risk option combinations to consider:

 

 

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.......………………...……........Cash Outlay……….....Cash Inflow

Buy 100 shares of Boeing @ $78.12 …………...….$7,812

Sell 1 BA Jan. 2009 $80 Call @ 6.60/sh…...…......….$660

Sell 1 BA Jan. 2009 $80 Put @ $8.10/sh............….…$810

Net Cash Out-of-Pocket……………………......…….$6,342

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If Boeing shares are at least $80 /share on expiration date [+ 2.5% from our starting price]:

• Your shares willed will called [sold] for $8000.
• Your put will expire worthless [a good thing for you as a seller].
• You will own no shares, no options, and hold $8000 cash.
• You will have received two quarterly dividends of $40 each.

You will have a net profit of $1738 [including div.] on your cash outlay of $6,342.

That's a cash-on-cash return of 27.4% in < seven months on shares that only needed to go up 2.5% from your starting point.

Risk?

Your break-even on the stock you bought is $78.12 less your call premium received of $6.60 = $71.52 /share.

Your break-even on the puts is the strike price of $80 less the $8.10 put premium = $71.90 /share.

Overall break-even = $71.71 share. That means even if BA shares dropped by $6.41 or 8.2% you'd still be ok or making money.

If you're willing to commit to January of 2010:

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………………………....….Cash Outlay……..…Cash Inflow

Buy 100 shares of Boeing @ $78.12 …………….$7,812

Sell 1 BA Jan. 2010 $80 Call @ 11.50/sh……….$1,150

Sell 1 BA Jan. 2009 $80 Put @ $12.10/sh....……$1,210

Net Cash Out-of-Pocket……………….....……….$5,452

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If Boeing shares are at least $80 /share on expiration date [+ 2.5% from our starting price]:

• Your shares willed will called [sold] for $8,000.
• Your put will expire worthless [a good thing for you as a seller].
• You will own no shares, no options, and hold $8,000 cash.
• You will have received six quarterly dividends of $40 each.

You will have a net profit of $2,788 [including div.] on your cash outlay of $5,452.

That's a cash-on-cash return of 51.1% in < 19 months on shares that only needed to go up 2.5% from your starting point.

Risk?

Your break-even on the stock you bought is $78.12 less your call premium received of $11.50 = $66.62 /share.

Your break-even on the puts is the strike price of $80 less the $12.10 put premium = $67.90 /share.

Overall break-even = $67.26 share. That means even if BA shares dropped by $10.86 or 13.9% you'd still be ok or making money.

Comments

[DutchMark]

Your return calculations for the option plays are severely flawed. Selling a put is equivalent to a covered call. Therefore you should consider your cash layout to be more than double of what you used. That means your expected returns are also less than half of the ones you calculated. No wonder those scenarios look so promising.

Selling puts is not free money with no downside risk, as is implicated by your article.

[TickL Me Elmo]

The cash outlay is exactly as indicated.

I fully disclosed you may end up with a double position but if the stock does as is indicated [stays above the put's strike price] in the examples you will not ever lay out any additional cash.

[dpf]

Mr Price - thank you for your excellent articles - I am new to options and find your trades very informative.

[Asen]

DutchMark and truthinvesting correctly point that the calculation is not much correct. There is also option requirement over selling of PUTS that make the needed capital to perform the trade - DOUBLE. So, the ROI is not correctly calculated

[TickL Me Elmo]

Margin requirments ARE NOT cash outlays. I write all positions against paid-up marginable securities so all cash-on-cash returns are 100% accurate.

Option sellers actually earn money on premiums received. There is no 'cost of capital' on option sales. There is an 'opportunity cost' in terms of tying up buying power.

[TickL Me Elmo]

If you sell a put that goes on to expire worthless:

You will have collected the full premium [less commission], earned interest on the cash for the full time period until expiration and never have had to lay out any cash [if you wrote the puts against marginable securities that were already in your account].

[MILESCFA]

Since selling a put is equivalent to a buy-write, you could sell 2 of the puts and accomplish the same $profit and risk profile. This requires NO CASH outlay, so what's the cash-on-cash return?

While I agree with your math, I think what the others are trying to point out is that it's "the wrong math". My broker requires only $3,500 on my trade but $12,400 in margin for your trade. This means selling 2 puts rather than your trade generates about 3 times the return-on-margin (43% vs 14%) (This is the "return on investment" because you have to have $3,850 vs 12,400, respectively, to make the trade).

The only reason to do a buy-write is that naked puts aren't allowed in IRAs.

[TickL Me Elmo]

If you strictly sell naked puts you'll never get the chance at paying long-term capital gains [now 15%] as you can with stock you buy and write calls on.

No matter what period of time you are short an option there is no holding period so all eventual gains are treated as short-term.

I like to sell naked puts by themselves also. These write-ups are just examples of what I think look like good moderate to low-risk combinations.

[MILESCFA]

I only trade (simple-to-complex) option trades. What's "long-term" :-) ?

[TickL Me Elmo]

'Long-term' is for trades that have a holding period of greater than one year.

Short sales have no 'holding period' as such. You can be short a LEAP for two years but the trade still counts as 'short term' for tax purposes.