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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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  • Abbott LEAPS Are Attractively Priced 4 comments
    Dec 18, 2012 9:26 AM | about stocks: ABT

    Yesterday I bought some ABT Jan 2014 50.0 calls for $15.60. With the stock trading at $65.47 when I got it done, the time cost at 13 cents was very reasonable. If I had borrowed money to buy Abbott (NYSE:ABT) shares, it would cost me considerably more than that in interest.

    Abbott will be spinning off its R&D based pharmaceutical business as AbbVie (NYSE:ABBV) by means of a special dividend on 1/1/2013, and the new stock is expected to start trading on the NYSE the next day. The company's shares have been trading below their historical average multiples, and the transaction represents an effort to create shareholder value by letting the two separate parts of the company find their own level.

    The company comes up on a screen for dividend growth with above average quality, and is well-known and widely covered. Checking on FASTGraphs (I'm a paid subscriber), I interpret the charts to show that ABT is undervalued. I'm estimating the 5 year return from holding the shares at 10% annualized.

    Normally, my methods would involve selling covered calls as a way of funding the time premium on the LEAPS. However, with volatility as low as it is, there is very little cost to controlling the shares, and volatility may increase after the spin-off. The options I own will become non-standard, calling for the delivery of shares of both ABT and ABBV, plus a small amount of cash in lieu, since there will be no fractional shares.

    In any event, I feel that the low cost of controlling the undervalued shares makes for an attractive investment opportunity. After the transaction completes in January, I will continue to monitor developments, and sell covered calls if either of the two companies makes an upward move. Hopefully share prices and options premiums will increase when they are trading separately.

    As a disadvantage, my broker won't accept non-standard options as coverage for the sale of calls, so there will be some maintenance requirements.

    Disclosure: I am long ABT.

    Themes: Healthcare, Options Stocks: ABT
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Comments (4)
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  • Analytical Chemist
    , contributor
    Comments (295) | Send Message
     
    This may very well be cheaper than the interest on $50 per share, but 13 cents is only your time cost, not your total cost. With the option you don't get the dividend payment, which will be at least $2.04 per share over the next year. So your total cost is more like .13+2.04 = 2.17, or about 4.3%.
    It might still be a good investment, but 4.3% is significantly different than 0.26%.
    18 Dec 2012, 02:27 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (5306) | Send Message
     
    Author’s reply » That's true, it's an opportunity cost. The plan is, to sell some calls to receive premiums roughly equal to the dividends.

     

    The options pricing formula considers dividends, which is one reason why the LEAPS are so cheap.

     

    Selling the May 2013 70.0 calls would go a long way toward replacing the dividend income, although I have hopes that either volatility or a price increase in the shares will raise the premium on the calls a little further.
    18 Dec 2012, 02:47 PM Reply Like
  • Derek A. Barrett
    , contributor
    Comments (3534) | Send Message
     
    Thanks Tom was curious to see how people were using options for this spinoff. Hopefully we can expect similar behavior with PSX debut last year spinning off from COP.
    19 Dec 2012, 02:20 AM Reply Like
  • loonsong
    , contributor
    Comments (171) | Send Message
     
    Thanks Tom,
    I am long the stock and short the puts.
    I think your approach on this makes good
    sense and I plan to do the same.
    Thanks,
    Loonsong
    20 Dec 2012, 08:19 PM Reply Like
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