Tom Armistead's  Instablog

Back in June last year, I wrote up an options trade for Webster Financial (WBS), including a brief analysis of the regional bank's prospects and describing a diagonal call spread. It was one of four such trades I have done on this situation. Here's a summary of how I made out:

(click to enlarge)

The stock itself is not all that exciting, but starting from a relatively low share price in September 2009 diagonal call spreads have worked out well.

I checked the latest earnings report and conference call, and the situation continues to develop favorably, with increasing tangible book value per share and some progress being made in reducing the efficiency ratio to a goal of 60%. With tangible book value as of 3/31/2012 at $15.10 per share, and estimating an 11% return on tangible book, earnings would be $1.66. Applying a P/E of 15, I develop a target price of $25 by the end of the year.

Today I made the trade shown in the following analysis of possible outcomes:

(click to enlarge)

The static and expected cases both return a reasonable profit. The soft point of the trade is that the maximum probable loss is quite a bit bigger than the maximum possible gain. However, tangible book value at $15.10 provides a margin of safety here, and I'm prepared to hold the position if it moves against me.

Thinly Traded Options

Options here are thinly traded, with very high bid/ask spreads, especially on the deep in the money calls. However, over the years I've been trading this situation, it has been possible to get what I regard as fair prices. Implied volatility at 43.26% (per CBOE) is high enough to make the sale of the 22.5 calls attractive.

My experience with thinly traded options has been mixed. Sometimes it's possible to get very profitable trades, where you have to ask yourself, why would anybody take the other side of this? The main drawback is that it may not be possible to get good pricing when an adjustment is needed, and it may not be possible to exit on favorable terms if the investor wants to get out of the trade.

At this point the amount invested in doing the trade over again is less than the accumulated earnings, so I figure I will keep doing what has been working.

Disclosure: I am long WBS.

Additional disclosure: Diagonal Spread as described in the article.

Following up on the Berkshire Hathaway (BRK.A) shareholder meeting, various analysts and pundits have been trying their hand at figuring out what company Buffett didn't buy for $22 billion. Certainly it would make a nice rumor: it can be reheated at any time for the next year, good for a quick pop for the perpetrator. But the question here is, why is this phantom acquisition that got away so credible?

It's pretty simple. The Oracle is known for being greedy when others are fearful, taking a long term view, and buying quality. The thing is, there are a lot of quality companies trading very low, because there's a lot of fear out there, and not too much long term thinking.

Everybody knows this is the type of market that creates openings for the oracular octogenarian, but somehow it seems preferable sit on the sidelines and let him run with the ball.

I'm not going to name any names. There are plenty of single digit P/E's out there, plenty of cash heavy balance sheets, plenty of under-appreciated American icons, etc.

The most likely outcome is, those who huddle on the sidelines, listening to Nouriel Roubini, John Hussman, David Rosenberg et al, will be dumbfounded a few short years from now when the nimble nonagenarian will be skipping away with his winnings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Here's a link to an old song, sung by Tom Rush, a sad song about labor strife in paradise - "Joshua Gone Barbados." Tom Rush was a figure in the folk music scene when I was a teenager, and I really like his version, although he seems to have picked up a lot of grey hair in the intervening years:

http://www.youtube.com/watch?v=U0RLjoFtxyg

In the spirit of sad resignation, here's a few verses to the same tune, on the subject of MFG, and Corzine:

MFG collapsing, numbers turning red,

Spanish yields are rising, just like pundits said.

Corzine in the south of France, buy him a big Chateau,

Ask him where's the money, he say I don't know.

Congress grilling Corzine, where could the money be?

Johnny he just shake his head, why you asking me?

Some smart fellers checking, looking at the books,

SEC look high and low, trying to find some crooks.

Tracking down the money, asking where it go,

Get to JP Morgan, maybe Jamie know.

Asking Jamie Dimon, where could the money be?

He says in my pocket, now it belong to me.

So Corzine's back in Jersey, hiding behind his gate,

If you're looking for your money, you got a long long wait.