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Market Shadows: Group of writers and investors: Paul Price, Lee Adler, and Ilene.
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  • Become A Cat Lover

    Paul Price is SELLING one CAT Jan. 2014 $100 Put in the Market Shadows Virtual Put Selling Portfolio.

    Featured in: MarketShadows February 24 2013 Newsletter: Not Done Rising, But Night Will Come

    Become a Cat Lover

    By Paul Price

    The world's largest producer of earthmoving equipment has dropped dramatically since early 2012 as fears of a global economic slowdown have taken hold. Caterpillar (CAT, $91.45) topped out at $116.95 less than a year ago and was $99.70 as recently as February 1, 2013. The stock was trading for $91.45 at 3:15 pm EST on Friday.

    (click to enlarge)

    The three best buying opportunities of the past 26 months all came at P/E multiples and yields very similar to those now. Prior selloffs were associated with similar a negative psychological environment as present today.

    The riskiest times came from buying Caterpillar when all the news was positive. At those junctures, CAT sported higher P/Es and lower yields than now (see chart). Apple (NASDAQ:AAPL) was a similar story last fall. Traders were fearless going into AAPL above $700 last September, yet hesitate to plunge in today at around $445.

    CAT is rated A+ for financial strength and has outperformed 90% of Value Line's 1700 stock research universe over the long haul. Investors have been well-rewarded for taking on CAT's high beta (@ 1.35) and its inherent lack of near-term predictability in earnings.

    With CAT trading for $91.45, it offers a very sustainable 2.27% yield at only a 22.2% payout ratio based on the already reported, trailing 12-month earnings of $9.36. Dividend grew 197% since 2002. The annual rate climbed from $0.70 to $2.08.

    Even though CAT's earnings may dip in 2013, the 13% drop in profits expected by Zacks would still put CAT at just 11.1x its already reduced forward estimate. That is far from a scary valuation.

    Morningstar sees fair value as $106 or about 16% above Friday afternoon's price of $91.45. Standard & Poors takes a slightly more positive view with its 12-month target price of $117.

    (click to enlarge)

    Caterpillar offers solid upside through outright purchase. Selling one January 2014 $100 Put is a conservative way to play CAT's upside.

    Here's what the math looks like for writers (sellers) of a January 2014 $100 Put contract at current quotes.

    (click to enlarge)

    If we sell one Jan. 2014 $100 Put for $14.60 now, and CAT is trading below $100 at expiration, then 100 shares of CAT will be "put" to us at expiration - i.e., we will buy 100 shares for $100 on Jan. 18, 2014.

    Our net cost (break-even) will be $85.40/share because we keep the $14.60 premium for selling the Put. The $14.60 offsets the $100 share price we pay if CAT is trading below $100. Thus, as long as CAT is above $85.40 at expiration, we have broken even (CAT at $85.40) or achieved a profit (CAT above $85.40).

    If CAT rises to $100 or above by Jan. 18, 2014:

    • Jan. 2014 $100 strike-price put expires worthless
    • We keep $1,460 as pure profit (the put contract is $14.60 per 100 shares - a contract is for 100 shares)
    • Our obligation to buy CAT below $100 disappears

    This best-case scenario will occur on any move up of $8.55 or greater (+ 9.35% from the trade inception price of $91.45).

    If CAT remains below $100 on Jan. 18, 2014:

    • Jan. 2014 $100 put is exercised by the buyer
    • We will be forced to buy 100 shares of CAT per put contract sold for $100/share
    • We will need to lay out $10,000 in cash per put contract
    • Our final position will be 100 CAT at a net cost of $8,540 - i.e. we owe $10,000 for 100 shares, but that is offset by the $1,460 we collected for selling the put.

    The worst-case scenario purchase price of $85.40 per share is 6.6% below the trade inception price. It's closer to the 52-week low of $78.25 than to CAT's yearly peak of $116.95. The effective yield would be 2.44% based on the current payout level. Our P/E would be reduced to just 9.12x the actual 2012 reported EPS.

    We are going to SELL one CAT Jan. 18, 2014 put @ $14.60 /share to our Virtual Put selling portfolio today, Feb. 22, 2013.

    Disclosure: Long CAT shares at the time of publication.

    Tags: CAT
    Feb 25 12:33 AM | Link | Comment!
  • Quick Rise, Sharp Pullback- That's LIFE
    Quick Rise, Sharp Pullback- That's LIFE

    See also: MarketShadows February 24 2013 Newsletter: Not Done Rising, But Night Will Come

    Courtesy of Paul Price

    Global biotechnology supplier Life Technologies (LIFE, $58.19) was formed in November 2008 when Applied Biosystems and Invitrogen merged. The company has prospered since. LIFE was reportedly being courted for a buyout by publicly traded Thermo Fisher Scientific (NYSE:TMO) as well as some private equity outfits.

    It appeared a deal would be struck. LIFE shares surged to a new all-time high of $65.84 this year in anticipation of a bid. Last week the stock sunk back to the $58 range after terms could not be agreed upon.

    (click to enlarge)

    The company continues to do well. Adjusted earnings for 2012's Q4 and full year were both records. Management gave 2013 guidance of $4.30 - $4.45 which compares favorably with non-GAAP EPS of $3.98 for the year just completed.

    LIFE's strong business trends and international footprint would be attractive to many suitors. The 80% or so of total revenues that come from consumables/services mimic Gillette's classic 'Make money on recurring razor blades sales and don't worry about the margins on the razors' approach.

    (click to enlarge)

    LIFE was willing to sell but is holding out for a higher price than was being offered. Many times one or more of the interested parties will come back to the table. Research firm Morningstar saw fair value for LIFE at $64 as a stand-alone.

    (click to enlarge)

    The company bought back 13.8 million shares during 2012 at an average cost of $46.01 per share. Directors indicated another 2 million shares had been retired just since January 1, 2013.

    The stock has decent but unspectacular upside if no deal materializes. It could surge quickly again if takeover rumors resurface. I used last Wednesday's price dip and increased volatility to sell some January 2014 $55 puts for a premium of $4.20 per share. Friday's bid was slightly lower due to the shares' late-week stability. The $50 strike would allow for a lower break-even point while offering less potential profit if the stock holds steady or rebounds.

    (click to enlarge)

    Note: These options are not actively traded. Be sure to use limit orders that fall between the bid/ask spreads.

    Maximum gains on each put would come as long as LIFE closes at, or above, their respective strike prices ($50 or $55). Gains would be 100% of the premium received ($2.25 and $4.00, respectively).

    If LIFE closes below the strike price on the expiration date, the worst-case scenario would require purchase of 100 shares per put contract at a net outlay of the 'if put' prices shown in the chart above (strike price minus premium collected). $50 or $55 strike put sellers could sustain up to 17.9% or 12.3% drops, respectively, from the trade inception price without suffering a loss.

    We will place an order to sell 1 contract on the LIFE Jan. 2014 $55 strike with a limit of $4.00 when the market opens on Monday February 25, 2013.

    Disclosure: Short LIFE Jan. 2014 $55 puts

    Click here for a screenshot of the full Virtual Put Selling Portfolio that our LIFE put will be joining.

    Tags: TMO
    Feb 25 12:28 AM | Link | Comment!
  • Not Done Rising
    Not Done Rising

    Featured in: MarketShadows February 24 2013 Newsletter: Not Done Rising, But Night Will Come

    By Ilene

    Over the last four months, we've been buying (virtual) stocks and selling (virtual) puts, without hedging our bullish bets. We explained our reasoning earlier in the year:

    "We are starting 2013 long stocks in Paul's Virtual Value Portfolio with no covered call writing hedges for one reason - the Federal Reserve's and other central banks' plans to continue printing money into existence while debasing their currencies. This does not solve any problems such as too much wasteful spending, a perverse tax code, and a rushed-through fiscal deal that does not reduce the growing debt burden." (Comfortably Bullish)

    But stocks are one vehicle to help protect wealth during a time of money printing, zero rates, and devaluation of currency.

    Lee Adler of the Wall Street Examiner had asked 'Has orgiastic market shot its cash wad?' No...

    "The Fed will be pumping every other day now, and another huge slug of MBS [mortgage backed securities] purchase cash will be coming around mid month. That should outweigh any questions that might arise about the technical analysis, the biggest of which right now is how big this rally might be." In this issue, Lee wrote, "as long as the Fed keeps pumping, the tide of systemic liquidity should continue to rise exponentially in the US and stocks should continue to oscillate along that upward wave."

    Ambrose Evans-Pritchard had also argued that the world's central banks are racing to drive down their currencies, and that will increase asset prices. He warned, "Bears beware. A monetary revolution is underway:"

    The side-effects of this currency warfare - or 'beggar-thy-neighbour' policy as it was known in the 1930s - is an escalating leakage of monetary stimulus into the global system.

    So don't fight the Fed, and never fight the world's central banks on multiple fronts…

    The New Year ritual of predictions is a time for bravado, so let me hazzard that the S&P 500 index of stocks will break through its all time high of 1565 in early 2013 - mindful though I am of flagging volume and a wicked 12-year triple top… (Stocks to soar as world money catches fire, Calvinst Europe left behind - Telegraph)

    In Lights, Camera, Rally?, Paul Price argued,

    With the backdrop of very low interest rates, the overall 'should-be' P/E of the stock market increases because the alternative 'safe' investments are paying such low yields. Stocks become more desirable. This dynamic makes higher risk assets, such stocks, look even more attractive. And that's exactly what the Federal Reserve wants.

    The Fed is artificially holding interest rates down with its successive quantitative easing programs (QE1, QE2, QE3, QEternity….) and its Zero Interest Rate Policy (ZIRP). Part of Ben Bernanke's plan (or plot, some might say) is to compel investors to buy "risk-on" assets, such as equities and commodities - while interest rates are hovering near zero and the dollar is continually losing value."

    The Fed's Zero Interest Rate Policy should support higher multiples going forward. It may be cliche to say 'Don't fight the Fed.' But essentially, we are not going to fight the Fed.

    This week, in "Dow 20,000 Only a Matter of Time," Econmatters argued that we need to be invested due to the growing money supply and currency in circulation, and the printing press phenomenon. Money is being created to chase assets, and that will inflate prices. It's no accident.

    The Dow will blow past 15,000, 16,000, 17,000 and so on based upon the currency creation effects alone. The fact is that markets are liquid, capital will flow in and out, and there will be occasional major pullbacks. "Those who fail to time the market will suffer losses at times. Make no mistake, though, Dow 20,000 is a foregone conclusion."

    (click to enlarge)

    (click to enlarge)

    (click to enlarge)

    Econmatters argues that if the economy cooperates even modestly over the next three years, the Dow will hit 20,000. "Watch how the market performs once we break through the 14,200 level, and start putting in new highs in the other indexes. The pace can really take off once markets are in unchartered territory, and we can start taking 1000 point monthly clips that will leave you speechless... We are on the verge of taking that next leg up in the Dow, in fact, we should set a new high pretty soon; enjoy the ride as this breakout has been a long time coming." (Dow 20,000 Only a Matter of Time)

    In The Pullback Memo, EconMatters predicted the timing for the market's near-term upswing. March and April. (Yes, according to EconMatters, that's it for the first half of the year. If you've missed a few months of this run, too bad, it's over.)

    We are in the midst of the strongest four months of the investing cycle for each of the last four years. Basically, everyone and their uncle go long assets until late April before the annual summer selloff. Don't expect this year to be any different.

    The way I look at it new money comes into the market March 1st which is next Friday, so any window for a pullback has 5 days to occur, and less than that because everybody front runs the monthly 401k money that comes into the market the first of every month, and is usually good for a major Risk On day.

    So investors have 4 days for a pullback, you get the idea, Thursday's mid-day selloff was the pullback. There isn't going to be any ideal 7% pullback so all those who missed the rally can conveniently get right in with the rally that they missed for the first two months of the year.

    You think this stuff just happens randomly?

    There are no do-overs in markets! What were you thinking, haven't you been paying attention the last four years? You start going long in November of the previous year and you stay long until option's expiration in April, then you sell, wait for the summer sell-off when some crisis in Europe or Downgrade is the end of the world, and after the sell-off, then everybody buys back for the "Money Manager Make Their Numbers Yearly Close"!...

    Nothing stops the rally, we don't go backward, we just keep going higher till mid-April, Got it? Good, now quit your hoping, praying for the 7% pullback.

    Have we set new highs yet? I didn't think so…

    We will give you your damn pullback at the end of April after we have set new highs in all the market indexes. So don't ask "Are we going to pullback yet"? No we are not going to pullback, you will know when it is time for the pullback by checking the damn calendar!

    Here is the memo….. (The Pullback Memo)

    Source: etsy.com via Knick of Time Interiors on Pinterest

    Feb 25 12:23 AM | Link | Comment!
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