How I Plan to Trade My Depressed GM Stock

Soaring oil prices, changing auto and truck markets and the tanking stock market have thrown thousands of stock pickers and long-term investors in General Motors (GM) stock under a gas guzzling Hummer.

Although I have owned GM covered calls only since June 11, I'm one of the losers in the GM market. Millions of other long term investors have huge losses in the stock, compared with what I'm dealing with. I bought GM at $16.57 and at the same time sold GM July 17.50 call options for 96 cents. This put my breakeven at $15.61. The stock closed Thursday at $11.43 and the call options at 7 cents. So I've got a $3.29 per share, or 21%, loss on my trade. Annualized, that's horrible!

Why did I do this trade? I explained here. While I knew GM was in trouble and headed lower over the near term, I also knew that it was highly rated by Morningstar.com, which estimated its fair value at $27. Morningstar now has the stock "under review" for obvious reasons. It's assumptions have been thrown under the pickup.

Well, last anyone heard, GM's still paying a $1 per share dividend, which amounts to a 6.04% yield for me and 8.8% for those who bought GM at $11.43. So, if I collect the dividend for a year, my loss is reduced by a buck, assuming GM doesn't cut the dividend and the stock doesn't fall further. Both could happen. One reason GM has tanked in the last week is that analysts have determined it will need to raise capital. A dividend cut would be relatively cheap capital but would hurt employee and investors relations.

The July 17.50 (strike price) call options I sold a couple of weeks ago will expire out of the money on July 18. Then I can sell August 12.50 or 15 call options, depending where the stock is on July 21. I want to sell calls that are far enough out of the money so that there is little chance the stock will rise to the new strike price and be called, making me take my loss sooner than I want too. A call option with a 17.50 strike price gives the buyer of the call the right to buy your stock for $17.50 a share if the stock is trading at $17.50 or above. Indeed, my strategy is to collect the dividend and sell calls over the next couple of years. This would reduce my basis, or effective purchase price, and it would give the company time to begin to turn itself around.

Once investors see that a turn around effort is working, they will bid up the price of the stock, giving me a nice profit over the next two to four years, unless the stock is called prematurely. Thus my strategy for selling far out of the money calls. I'm speculating that GM can and will turn itself around with some help from gas prices, which I'm counting on going down. Congress is moving to limit the roles of pension funds, endowments, hedge funds and other financial speculators that have been inflating oil prices over the last two or three years. Some think that if their irresponsible speculative activities are curbed, oil prices could fall 50%. That would help GM's bottom line big time. I'm not that optimistic, because no one can predict what will happen.

Meanwhile, GM is shaking up its product line to meet the demand for vehicles that give better mileage. It could become a major importer of its smaller Opel and other high mileage cars it makes abroad. And it could and should reduce the number of models it offers, following the examples of Toyota, Nissan and Honda.

A company's success is 80% to 90% based on the business it's in and 10% to 20% based on management effectiveness. GM has been constrained by unions, legacy pension and retiree health care expenses, commitments to its thousands of dealers and suppliers and environmental laws. It's been virtually frozen in place. Now it's fighting for its survival, and a lot of those constraints have been and will be thrown under the SUV. Lots of workers and small business owners will be hurt while GM tries to satisfy consumers and environmentalists as well as shareholders.

The options markets are reflecting some optimism that GM will return to prosperity. Options that expire next January show that speculators think the stock will recover to between $13 and $14 before January 2009 options expire. January 2010 10 call options suggest the stock will recover to $14 before they expire while January 15 2010 calls show some speculators are counting on a rally to about $17. Bearish buyers of GM January 2010 15 puts, however, are speculating that the price will be under $10 a share when the options expire on January 15, 2010. As you can see, writing covered calls is a risky strategy, even when you buy stocks with high dividends.

Covered call trades limit profits, but not losses and require a trader to pay close attention to their positions. This strategy is not for passive investors. And there is absolutely no guarantee that my strategy for working myself out of this hole will succeed. I own GM covered calls. And I'm glad my position is tiny. I didn't bet the farm on this trade.

Disclosure: Author owns GM covered calls

Comments

[Medici]

Why not write puts as a supplemental play, the volatility spike has them trading above there theoretical value (on many strikes). This would offset your "covered call" position

[fxtrader07]

this was a bad trade that you really could have expected. many warned against it, myself included. covered call writing is fine, but doing it on stocks that have been in deep trouble for years if not decades without being able to fix even one thing is a surefire receipt for disaster. you were trading on hope then, as you stated yourselves and you are holding on just on hope now. GM stated they have enough cash for 2008 but declined any comment for 2009. a dividend cut might be the least of your problems and the correct thing imho would be to close this trade and take the losses as it was absolutely ill-advised in the first place.

[love4gm]

Must dispute your assessment of "A company's success is 80% to 90% based on the business it's in and 10% to 20% based on management effectiveness." That is a very superficial assertion and not fact based. The facts are fairly obvious, but missed by investors and analysts alike, simply because they lack the insight into the most accurate predictor of revenues from NA market for GM...Dealer (The true customer!) orders. BTW, ML's lead automotive analyst had GM pegged for a $28 price by July at the end of May!

Dealer orders are based on two basic premises, market demand and some seasonal adjustments. If you, as an investor, or an analyst truly want to know where the next 90 days lies for GM, Ford or Chrysler, then you need go no further than a handful of your local dealers. (Mix each manfacturer's brands and visit a few!)

Spend time asking the dealers (If you can get face time.), Sales Managers, and Salespeople what their current daily, weekly, monthly business has been like, as well as what the trailing quarterly business has been for them. This will help you gauge the overall health of the market, as well as the end-user and dealership mindsets (One is usually symptomaitc of the other. i.e. chicken/egg)

Back to point. The leadership of these giant, stoic and often callously arrogant automotive dinosaurs is stifled less by the fixed cost issues than by stale thinking at the top...period. Specifically with GM, the company wastes resources on inane committes, surveys and studies in order to guide its decision-making. It also fails to identify specific talents and acumen amongst its junior execs, preferring to create mediocre, well-rounded robots who toe the company's lines, rather than re-write them!! They spend more time and energy determining the whims and desires of those senior execs above them in rank in order to get ahead, this way they do not risk being left behind when their corporate "godfather" moves on. This is crippling these companies, more so than the issues eluded to in your post.

I hope for all of our sakes that there someone exists out there in the business community that can pull the GM ox out of the ditch. The big question then will be two-fold...Will they come from outside the insular confines of Detroit and will they be willing to take on the challenge? I suspect G. Richard Wagoner hangs on simply, because the BOD is a weak collection of his personal appointees and there are no willing takers out there! Good luck.

[notsosmart]

when they cut the dividend i sold @$22. took my loss & never looked back at this dinasour.without a total change at the top inc.BOD i fear this co.will go belly up.

[Glenn Mercer]

One more thing to think about. Yes, we all know "Product is king." Agreed. If GM can turn out great new product, a turnaround will ensue. But the question in my mind is, "How fast?" Consumers do NOT, when shopping for a car, write down all their options and then rank order them and buy whatever is in spot #1. Just like when, for example, you and the spouse choose a restaurant to dine at, you do not look up all eateries in a 10-mile radius and rank-order them. You choose from a pre-selected and proven list of familiar favorites. Same in cars. If X has owned three Hondas in a row and they were fine... and one hapless Pinto way back in college, X has precious little incentive to now consider Ford again. Over time, as they hear better and better things about Ford, see positive reviews, talk to a neighbor who owns one, they will re-consider the brand. But this takes time: years. J D Power reports that about 40% of the American public will not even CONSIDER a Detroit product. To drive consideration up, GM has been pulling out the stops: free over-the-weekend test ownerships, side-by-side comparos with Toyotas, contests for just stopping in the dealership, etc. These are all the exactly right things to do. The question is, will Detroit's cash run out before the consumer tide slowly, slowly turns? Remember, a car company's "conquest" vehicle is not this year's new car, it is the car they made 8 years ago, and consumers' memory of that vehicle. With the average age of a new car buyer at 45, most of us are buying used for years before we spring for the new beast, and so we are basing our choices on experience with Detroit's "bad old days," not today's great new products. Can Detroit change our minds fast enough?

[Christopher White]

I sell advertising to franchise stores in the midwest and FL and I have seen business deteriorate to the point that i am concerned that any of the domestics can survive, period. For example, last week i spoke with a finance manger at a Dodge store in Cleveland. He told me in May Dodge sold 24,000 units in the region and they had a goal of 20,000 units for June...as of the 19th, only 4,200 units were put over the curb. Last month, around the 10th, i was speaking with a used car manager at a big Chevy store in Tampa. He told me that in the past, the #1 Chevy store for sales nationwide would have delivered around 300-350 units by that time but now the #1 store had a mere 64 units out.

[johnhaskell]

a better option strategy would be to buy puts, and forget about your equity position.

It's a very special management team that can get their stock back to where it was in December 1974- after the first oil crisis, Nixon's pardon, South Vietnam collapsing...and that's not even adjusted for inflation!

Jog my memory on how GM's diversification efforts into satellites, data management and subprime lending worked out?

I hope you'll stay in the market, though, as the rest of us need someone to trade against. Have you thought about shorting oil? The Saudis say they have a lot, and they would never lie about something like that.

[Donald E. L. Johnson]

My strategy is simple in this bear market. I am trying to generate income of 15% to 25% annualized, depending on the stock. I pick undervalued 4* and 5* stocks that pay dividends of 3.5% to 10% and write covered calls that generate annualized revenues of 10% to 60%. While dividends may be cut, most won't. And while covered call premiums vary month to month, they will let me generate a better return than just buying dividend stocks or CDs. The key is to sell calls that are far enough of the money that the stock, especially a depressed stock, won't be called, leaving me with a loss. The other key is to keep risky trades like this one small and to have several positions so that risk is diversified. I decided not to take my losses on this trade because I think I can work it out over the next couple of years. Time will tell if this works.

[TA]

I am in the same boat with BAC which is sold anytime the market is open. Do I cut losses or ride it out with covered calls and dividends? Well I like Ken and the Countrywide deal(the tax breaks, servicing portfolio, etc) but most of all I just like the retail banking business as it's a consistant money generator(when not abused) so I guess I'm riding it out, warts and all - time will tell if I'm wrong.

Unfortunately I can't say the same of GM. The auto industry has always been a bad business - it's not a typical Buffett business I like(wide moat, etc).

That said GM is way oversold, left for dead and good for a trading bounce but I wouldn't be into the dividends or covered calls for that.

[Jackson Cash]

I could not agree more with "gearhead". Having been the unfortunate owner of a 1997 Ford Taurus procured in 1998. Within 5 years I had the following remove my consideration for a Detroit auto for the rest of my life: 3 transmissions, 5 starters, electrical problems (interior lights that would not shut off thus draining the battery) and finally a blown gasket that incapacitated the engine. I am 30 years old with many cars to purchase in my lifetime. Will I ever consider another Ford? NOPE, not even if the Cubs win the World Series -- UNLESS Ford showed up at my door with even a used Taurus that I could freely extract the remainder of value from the first. That being said, the real crux of the matter on transmissions was the local Aamco mechanic said the transmissions failed because on "some cars Ford left out a $.25 plastic tube". I now own Toyota, Nissan and BMW.

[paulk8756]

Maybe you could buy some puts as a hedge if you don't just want to sell the stock and take your loss. I would, though.

So, what's the worst case scenario for GM right now? If they fail outright, the Dems will simply bail them out after the next election.

Unfortunately, knowing how they look at things, that will also leave the stock owners and bond holders out in the cold.

[paulk8756]

Conversely, what's the best thing that could happen? Maybe the Volt will be a huge success, and with the Congress supplying generous tax incentives so buyers can afford them, they'll sell millions across their product lines and eventually return to profitability.

But that's years away, and would require a lot of "ifs" in any event. Wouldn't it just be simpler to sell your GM and buy oil? And a lot less "speculative"... for sure... ha, ha!

[paulk8756]

Let's see if I understand this... you own the General AND Countrywide? Maybe this will help, try looking at the list of 52 week highs in IBD and go from there.

[paulk8756]

Or watch Cramer and do your own research on his investment ideas. And STOP bottom fishing! That's why they call it, "Trying to catch a FALLING KNIFE...!!!

[paulk8756]

Look, I'm not making these suggestions because I'm so smart or I'm trying to be a smart-ass. I used to invest in out-of-favor equities myself looking to make the BIG SCORE. When I counted my money, however, I eventually figured out that didn't work.

Institutional investors control the marketsmytheirsheervol...

[paulk8756]

...volume. And they get fired if they make mistakes. So they develop a "herd instinct" to survive. That's why they go with what's ALREADY working and pick current winners.

[samb]

I think you'll have to wait a couple of years to see how this turns out, GM could be in trouble until 2010. Hope they dont fall down to were fords at.

[huangjin]

The best trade is to go to some homeless people and see if you can get a shopping cart full of empty soda cans for your shares.

[Mister Jimmy]

I leased a 2004 Toyota Sienna and suffered almost $3,000 in electronic and mechnanical repairs, all due to component failures, before 70,000 miles. Even in the warranty period, Toyota dealers take a "you did it" attitude. Japanese vehicles are tremendously overrated and trading off of a 20-year-old reputation, just as the Detroit car makers are suffering from the bad product of 20 years ago. The facts have changed. The perception hasn't.

[notsosmart]

a good question with a simple answer to all the above. if you were to buy a new car this week what make ?what model? why? thank you.

[Donald E. L. Johnson]

I follow William O'Neil's approach in bear markets, not in bear markets like this one. I expect to hold GM and some other covered call dividend payers for several years instead of a few weeks. When bull markets return I'll rejoin the momentum crowd. Yes, there is momentum in energy, but I think that bubble could burst anytime, making energy riskier than where I am now. A bubble burst in energy would help the rest of the market.

[Donald E. L. Johnson]

Correction, I follow the momentum stocks in bull markets, seldom in bear markets.

[techy]

i am not an expert, but i have put some money in some dividend paying stocks. where i sell covered calls out of the money(keeping 10-15% profit).. and buy puts with the premium i got from the covered call...(10-15% loss).

and this guy was into GM who have 40 billion of negative balance sheet??

and this trading strategy made it to seeking alpha?? wow..

[Donald E. L. Johnson]

Hey, techy, I took a calculated risk, which isn't working so far but could work out over time. Writing covered calls and selling puts makes commission houses rich. I hope it works for you. I've learned some things from this trade and this thread. Stay tuned.

[techy]

donald..

how hard is it to know that you are paying insurance to get a good night sleep.

dont you have a auto insurance or home insurance? yup those make those insurance companies rich if you dont have accident.

but i have news for you, in the past when my stocks tanked, puts were there to get my money back.

and if my stocks fly i still make 10-15% profit.

lets say i want to play a bounce game with GM, i know it is a very speculative play and it can go to zero or it can go to $20 in next six months.

i will simply buy multiples of 100 stocks, sell 12.5 strike calls of Jan 09, and buy $10 strike puts of jan 09.

if my hunch worked out and it went up i may make good profit.

if nothing happens i get my money back.

if it went down a lot, i lose $1.5 for every stock..

dont you agree its a safe way to play the current volatile market (what if you one morning find that asia has sold off by 15% and wall street is down 10%....does that remind you of anything :)

[Steve Funk]

Just looking at this forum is enough to tell me to stay out of auto stocks for now. People who have never seen a full JD Power quality survey are comparing BMW's and GM's and inferring what the stock will do (btw, BMW has a terrible reliability record, much worse than GM). Clearly there are many investors who drive cars and think they understand the auto business. When the crazies are investing on emotion it is time to get out.

GM has pulled off miracles of fund raising in the past (1992) but it looks even harder this time. All auto companies burn cash at high rates due to hard capital and labor laws cannot reduce those expenses quickly. If GM cannot raise capital by this fall they will have to be taken private like Chrysler and there will be no stock bounce. (Bill Gates could write a check for GM right now).

[ncuman]

June report came out and as bad as it was, GM STILL outsold Toyota.
This combined with the fact that GM's paper value is now less than Ford even though Ford sells LESS automobiles and is experiencing much the same problems GM facing. Plus GM is way too big of a company for the government to let it fail. It will be bailed out ala Chrysler if need be. I think this is a classic example of MARKET OVERCORRECTION. This is providing a great opportunity for those willing to take a little risk on an undervalued stock.

Here is to BUY LOW and SELL HIGH.

[samb]

I think your right GM will make a come back, But i think there going to drop a little lower in the market, The bad thing is they have nothing on the table SUV'S are dead and the truck market is slow, They waited to long and now they are closing most of there truck-suv plants,They dont have a desent car to sell. Maybe Saturns will support them untill they get back on there feet. I would buy GM stock if i had any money " but i cant sell a car " !!!