I wrote about DuPont (DD) in the last week of September, observing a weakness in the upward move of the stock. In that article I said I was not expecting the stock to move up much further. Since then (when the stock was trading at $51.57), DuPont has dropped and is presently trading around $43.95. At the time, I had suggested a bearish income trade on the stock as follows:
Presently trading at $51.80, I would expect a bounce off the resistance level of $53 because of economic conditions. Because of this, I am [using] a bearish income play on the stock.
-- Buy the January 2013 puts with a strike of "52.50" (priced at $2.79)
-- Sell the January 2013 puts with a strike of "50.00" (priced at $1.68)
-- Net Debit to Start: $1.11
-- Maximum Profit: $1.39
-- Maximum Risk: net debit
-- Maximum Length of Play: 4 months
Reasoning Behind the Trade
-- Decreasing sales and shrinking revenue is never bullish
-- Macro economic environment is not favorable to short term growth
-- Resistance level is too strong in these market conditions
-- There is no visible catalyst to vault this company forward presently
Today, Nov. 8, I closed out this trade.
- Sell the January 2013 "52.50" put for: $8.80
- Buy back the January 2013 "50.00" put for: $6.55
- Gross Profit: $2.25
- Net Profit: (GP $2.25 - Net Debit $1.11) = $1.14
- ROI: 102.7%
Profits like this do not happen often, and I do consider these fairly lucky. But this is a good example of combining short-term income strategies with long-term investment portfolios to increase one's net worth.
I did not know the stock would fall like it did. Was it the decreasing sales and shrinking revenue that caused this stock to turn down? Recently, Piper Jaffray & Co. downgraded DuPont to neutral and lowered its price target. With the steep gap down, it was hard to sit back and continue to call the stock's performance "overweight." DuPont does work in a cyclical environment and has struggled attempting to improve profits from its safety and protection and electronics segments. Piper Jaffray believes the stock will remain low, trading in a range-bound manner through mid-2013.
The company's biggest drop in four years came after it announced lower-than-expected profits and the need to lay off 1,500 workers in order to cut costs. The global market is not chasing solar cells or paint pigment right now. But I believe the net income drop is what has really hurt this company. It dropped from $452 million down to just $10 million.
The bottom line for this stock is this: Presently there are better investments. JPMorgan expressed the same sentiment. The last week of October it downgraded DuPont from overweight to neutral. Its reasoning? It believes there will be better entry prices elsewhere because of near-term and years' worth of uncertainty ahead. DuPont's construction-related business is weak and EPS through 2013 will really have a hard time growing, according to the Morgan analysts.
For this reason, I agree that a long0term investment right now might not be the best decision. This does not mean the company is not a good company. It is based on the idea that there may be other better investments right now. But this does not mean one cannot utilize a short-term income opportunity on the stock.
Click to enlarge image.
The Options Play
The stock is presently trading at $43.72 and will be hard-pressed to move up at this point. Not only is the stock very weak, but there are major elements to deal with, including the European debt crisis and our own "fiscal cliff." Both of these elements will have a negative effect on the markets. I like a credit spread play for December.
- Sell the December 2012 call with a strike of "47" (priced at $0.18)
- Buy the December 2012 call with a strike of "46" (priced at $0.11)
- Net Profit: $0.07
- Maximum Risk: $0.97
- Maximum Length of Trade: six weeks
Reasoning Behind the Trade
- The stock is a bearish play against the trend on a credit spread.
- Strong resistance at 46.5.
- You'd be hard-pressed to find a catalyst to move the stock up at this point.
Disclaimer: Credit spread trades are high risk and one must understand risk management and have a good exit strategy before entering a trade like this. Unlike a debit spread trade that has limited risk, these trades are a lot riskier without a good exit strategy.