A 'Cheesy' Options Combination for Buffett Lovers

They are lots of Buffett fanatics here that think Kraft (KFT) shares are due for a nice rally. At today's price of $30.14 that's certainly not a crazy proposition.

Here's a very low risk play [for KFT believers] from now through December 19, 2008:

…………………………………….….....................……Cash Outlay………..Cash Inflow
Buy 500 KFT @ $30.14 ………….............……….. $15,070
Sell 5 KFT Dec. $32.50 Calls @ $0.95 ……............……………………… $475
Sell 5 KFT Dec. $32.50 Puts @ $3.50 …………………..........………… $1,750
Net Cash Outlay …………………...............……….. $12,845

If Kraft shares are > $32.50 [+ 7.8% from your starting cost]
on expiration date (Dec. 19, 2008):

Your shares will be called (sold) for $16,250.
You will have collected three quarterly dividends totaling $405 [if the calls were not exercised early].
Your puts will expire worthless [a good thing for you as a seller].
You will have no shares, no option obligations and $16,655 cash.

That's a net profit of $3,810 on a cash outlay of $12,845 or + 29.6% in just over 6 months.

That occurs as long as KFT has risen to at least $32.50 by December 19th.

Risk?

Break-even on the shares is $30.14 less the $0.95 call premium = $29.19.
Break-even on the puts is the $32.50 strike less the $3.50 put premium = $29.00.

Worst case you'll own 1000 shares of Kraft at a net cost of $29.10 /share.

At that price KFT would yield 3.71% and have a P/E of < 15 on 2008 estimates of $1.95.

Disclosure: Author is long KFT shares and short KFT options.

Comments

[Alex_G]

Holy Crap, a money making idea!! Thx, baby!!!

[Richard Schweitzer]

Look deeper and compare opertaions in the food processing and distribution businesses.

Currently, concentrate on the problems managements face in distribution - especially with KFT's diverse lines of goods, and refrigeration requirements.

Next compare the ROE of KFT (which I believe is somewhere below 10, with say HNZ which is somewhere above 30.

The probable scenario: A European purchase of KFT by a dairy goods specialist (Dannon?), followed by a break up and sell off of other lines to specific goods distributors (some of whom will be over-optimistic as to the value of brand names).

Possible net yield: est. $37 max.

Disclosure: Long KFT from spin off by MO

[Paul Price]

Richard,

Your scenario sounds fine if it plays out as you forsee it.

It would mean the max profit of 29.6% in six months for those who put on the trade described.