The strategy of selling a put to purchase calls provides you with the opportunity to leverage your position in a stock, and the chance to get into the stock at a much lower price. Only put this strategy to use if you are bullish on the prospects of this stock as there is a chance that the shares could be put to your account. The stock we are going to look at today is ArcelorMittal (NYSE:MT). Before we get into the strategy we are going to provide a list of reasons as to why we think this stock could make for a good investment.
Reasons to be bullish on ArcelorMittal (MT):
- A levered free cash flow of $4.98 billion
- A long term debt to equity ratio of 0.4
- A decent yield of 4.00%
- Analysts have a median price target of $23.59 on the firm
- A long term debt to equity ratio of 0.40
- Projected year over year growth rate of 83% for 2013, according to dailyfiance.com
- Sales increased from $65 billion in 2009 to $93.9 billion in 2011
- Net income rose from $75 million in 2009 to $2.25 billion in 2011
- EBITDA increased from $1.02 billion in 2009 to $9.2 billion in 2011
- Cash flow per share increased from $4.88 in 2009 to $5.04 in 2011
- A high beta of 2.62 which makes it a good candidate for selling options. Stocks with higher beta's command higher premiums
- It has an estimated 3-5 year EPS projected growth rate of 21%, according to Zacks
- Zack's has earnings per share estimate of $2.45 for 2013, which represents an increase of 115% over its 2012 estimate of $1.14
Charts and data of interest on ArcelorMittal (MT):
The steel sector has taken a massive beating, and one could argue that it's well due for bounce in the short to midterm time frames. In reality, this is taking place as we speak as several of the stocks in this sector have put in a bottom and is starting to trend upwards. On a long-term basis taking a position in some of the plays now could prove to be a move in the right direction. In addition to Arcelormittal, there are two other plays that warrant some attention. United Steel (NYSE:X) and Nucor Corp (NYSE:NUE). Nucor appears to be the strongest out of the 3 as it bottomed out in May. United Steel has put in a double bottom formation and appears to be trying to break out now. If United Steel closes below $17.67, the outlook will turn to bearish, and it will probably put in a new 52-week low before trending higher.
We feel that ArcelorMittal offers the best potential out of the three stated plays. It has been trading in a tight range since June of this year. Essentially, this is a rather narrow channel formation with the bottom at $13.70 and the top roughly in the $16.30 ranges. This type of formation is especially bullish if it occurs after a stock has experienced a strong pullback as happens to be the case with ArcelorMittal. A decisive close above $17 would serve as a strong indication that it is ready to break out and test the $19-$20 ranges, with the possibility of spiking to $21 before pulling back. As there is pretty strong dose of resistance in the $16.00-$16.30 ranges, the stock could pull back to the $15.00-$15.50 ranges before breaking out. It would also maintain the bullish pattern of putting in a series of higher lows since June of this year.
Suggested strategy for ArcelorMittal
This play has two parts to it. The first part entails selling a put and in the second part calls are purchased with the proceeds from part 1.
The March 2013, 15 puts are trading in the $1.634-$1.68 ranges. We would wait for the stock to pull back to the $15.00-$15.50 range before purchasing these puts. If the stock pulls back to the above range, these options should trade in the $2.00-$2.15 range. We will assume that the puts can be sold for $2.00 or better if the stock pulls back to the $15.00-$15.50 range.
The March 2013, 18 calls are trading in $1.15-$1.18 range. If the stock pulls back the stated range, these options should trade in the $0.80-$0.90 range. We will assume that the calls can be purchased at $0.90 or better if the stock pulls back to the $15.00-$15.50 range.
Benefits and Risk associated with this strategy
You have an opportunity to significantly leverage your position in this stock for a relatively low fee. You would only need to put up $1500 to secure the put, but you would be in a position to control 200 shares.
If the stock trades below the strike price, you sold the puts at, the shares could be assigned to your account .Depending on the number of calls you purchased your cost per share could range from $13.90 (if you purchased one call only) to $14.80 (if you purchased two calls). Assignment usually occurs on the last trading day of the option. As long as you are bullish on the stock, the possibility of having the shares assigned to your account should not be an issue, as this strategy provides you with the chance to get into this stock at a lower price.
As long as you are bullish on the stock and would not mind owning the stock at a lower price, the only real risk is that you have a change of heart, and perhaps you now feel that the stock could trade well below the strike price you sold the puts at. One solution to this is to roll the put. Buy back the old puts and sell new out of the money puts.
The markets are in a volatile phase, and it has been a long time since they experienced a correction in excess of 10%. Investors should consider closing half the position out if the calls are showing gains in the 60%-100% range. If you are not interested in having the shares assigned to your account, then buy back the puts you sold when you decide to close out your call position.
Options tables sourced from yahoofinance.com. Option Profit loss graph sourced from poweropt.com. Earnings estimates sourced from dailyfinance.com
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware