Sirius XM - Call It A Profitable Trade

Aug.17.12 | About: Sirius XM (SIRI)

No one ever lost money taking a profit

Bernard Baruch

Sirius XM Radio (NASDAQ:SIRI) investors have a lot to be happy about right now with the stock up more than 40% so far this year. They are also among the most passionate on the net, have very long - and selective - memories, and never lose the opportunity to gloat. Write something bullish about the company, and an author becomes an instant genius. Write something remotely critical about their Sirius XM investment and it's worse than insulting their family, their heritage or their pet dog. Write something outright bearish, and the author is lucky to only be called an idiot. And, if one recommends shorting the stock, well...

Share Price Volatility

Sirius XM is a very volatile stock. In 2011, the price of the stock started the year at $1.63, rose to $2.44 by May, fell as low as $1.27 in early October and finished the year at $1.82. This year the volatility has continued. Beginning the year at $1.82, the shares ran up to $2.41 by the beginning of April, gave back all of its gains by mid-May - falling as low as $1.78 and has since climbed to a post-merger high of $2.60.

Will investors see a repeat of 2011? Has Sirius XM hit its high for the year? Many analysts don't seem to think so. According to one survey, the analysts all have rated the stock as a hold, buy, or strong buy and have a mean price target of $2.75 with a high of $3.35 and a low of $2.25.

Making Money in this Environment

Investing is all about making a profit. Bernard Baruch is credited with a host of quotes about investing, including the one at the top of this article. Others include:

Don't try to buy at the bottom and sell at the top. It can't be done except by liars.

If a speculator is correct half of the time, he is hitting a good average. Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.

I tend to be a conservative investor, but recognize that more speculative stocks can enhance a portfolio's total return. Because of the price volatility, I have usually considered Sirius XM a speculative stock and keep it in the 10% of my holdings allocated for that purpose. There have also been occasions when the price fell below what I considered fair value and wanted to increase my position. Was there a way to increase the position without violating my "10% rule"?

I thought so, and wrote an article last September about using covered calls to get a high return at reduced risk. In fact, I thought the risk was so low, I could justify the position as non-speculative and move it to the other 90% of my holdings. On September 12, 2011, in a comment on that article I wrote:

In the interests of full disclosure, this morning I executed the combination trade in this article, buying SIRI and simultaneously selling the $2 January 2013 call for a net cost of $1.30. The stock was purchased for $1.69 and the call was sold for $0.39. My current intention is to just forget about it and wait for the shares to be called away.

That's a return of more than 50% in just over 16 months. In January of this year I wrote another article about using covered calls to turn a speculative investment into a more conservative one. At the time the shares were trading above the $2 strike price I selected. The point was to write what are known as "in-the-money" covered calls, anticipating the shares would be called away with an 18% return in a little less than a year.

Regardless, some longs can't resist the opportunity to gloat. The following comment appeared yesterday on a more recent article:

Bummer Crunch, the shares you sold covered calls against at 2.00 gone, now the 2.50s gone. Next up 3.00 . It has to be hell being long on a stock & having a constant upset stomach as it goes up day after day after day.

The $2 calls were written with the expectation that the position would be liquidated in January of 2013. The $2.50 calls are a very small position, with the breakeven at $2.72 (if the shares are trading over $2.72 at expiration, some upside will have been forfeited). If the shares are over $3 in January, I'll be happy to take my profits.

Are Sirius XM shares above Fair Value?

I received an email from a close friend yesterday asking me what I thought about buying $2.50 or $3.00 calls. Part of my reply was:

I've never been great at predicting the short term price swings on this stock. It frequently goes way above what I think of as fair value, and right now at $2.59 I think it's way ahead of fair value. That's about 25x 2012 free cash flow on a fully diluted basis. If I did not have calls to unwind, I'd consider selling and waiting for a lower re-entry point. I also think it's far more likely to go down about a quarter than up a quarter from here.

Could it work out with calls? Sure. I wrote an article about how the price defies logic, and logic tells me the price is too high. Longer term, I'm still bullish.

Even using a $1 billion free cash flow figure for 2013, at a $2.60 price, the multiple is still 18x. The analysts' mean target - a target that is typically for 12 months away - of $2.75 seems reasonable to me. But $2.75 a year from now does not equate to $2.60 today.

Summary

Baruch also wrote, "When good news about the market hits the front page of the New York Times, sell." Sirius XM has been getting some very favorable comments from the analyst community lately. Much of it is tied to speculation about what Liberty Media (NASDAQ:LMCA) will do if, as expected, it takes control of Sirius XM. Will there be a Reverse Morris Trust with the shares spun off to Liberty share holders? Will Liberty keep control of Sirius XM? Will there be a massive share buyback?

Whatever happens, the analysts seem very positive towards Sirius XM. I am bullish on the long term prospects for the company, although I think the stock has run a bit ahead of fair value.

Within the next 5 months, Sirius XM longs will continue to have the opportunity to gloat about the covered call disclosure statements at the end of these articles. I will be unlikely to convince them that I am really satisfied with my trading strategy. One final Baruch quote:

The main purpose of the stock market is to make fools of as many men as possible.

Disclosure: I am long SIRI.

Additional disclosure: I have $3 January 2013 covered calls against most of my Sirius position, as well as some $2 and $2.50 January 2013 covered calls. I may initiate (or close) a buy stock/sell option position in Sirius, at any time. I have no positions, or any plans to open positions in the next 72 hours, in any of the other companies mentioned in this article.