REHeakins'  Instablog

Welcome back readers. We know you're expecting this week's Week In Review, especially since it is an expiration day, but the review will be postponed until Monday afternoon. At that time we will go over the conclusion of our strategies that are ending in May, and look at how to move forward with them, if at all.

In the meantime, we want to introduce the more involved investors among you to a relatively underused method of analysis called Fusion Analysis. It is a method of combining fundamental, technical, behavioral, and quantitative analysis techniques into a comprehensive method of investing. While the method is not anything new, there are still very few investors and funds that decide to mix these disciplines together - most decide to focus on either fundamentals, technicals, or other more exotic criteria in order to find investments. The Fusion method may be quite involved due the numerous disciplines required to apply it effectively, we believe it can be effective for the investors willing to take the time to apply it in a manner suitable for them. We have always believed a comprehensive approach to investing will end up being more beneficial as compared to a more narrowly focused view. One of the leaders of this approach is John Palicka, CFA, CMT. His book, Fusion Analysis, goes into detail about the methods of combining these analysis methods, and provides case studies to better educate the reader. Take a look at this introduction to Fusion Analysis he wrote for the "Technically Speaking" news letter back in 2005.

So if you're looking for something to tide you over for the weekend, we recommend taking a peak at the introduction, and if you're more interested in the method, to give the book a shot. We'll be back on Monday with a day packed full of Covered Call Strategies.

Posted by OaktreeAdvisors at 5/17/2013 12:00 PM
Categories: Week In Review

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05/13/13 Covered Call Pick: Clorox Co (CLX)

For our first article on Clorox go here.

Clorox Co. is a U.s. based manufacture of consumer staple products such as cleaning products, trash bags, food items, and water filtration systems. Founded in 1913, this Oakland, California based company is best known for their iconic consumer brands such as Brita, Formula 409, Glad, and their namesake bleach brand: Clorox.

Clorox has a market capitalization of $11.34 billion with 131.7 million outstanding shares.

Clorox currently pays a $0.64 quarterly dividend for a current yield of 3.0%.

With a beta of 0.44, CLX trades with approximately 55% less volatility than the current market.

This is a new first for our Covered Call blog. We are creating a new strategy on a stock that we already have an open strategy for. We've done several revisits on strategies as they have expired or the stock has gotten called away, but this is the first time we have decided to generate a new strategy while an old one is still running. So why did we decide to do this now, and why with Clorox?

Well firstly, our initial strategy for Clorox is basically locked in. Back last August, we bought Clorox and sold the in-the-money $70 Call. With the stock now trading at over $85, we don't think the stock will end up being under our strike price by January (barring a total economic collapse) so we're basically locked in at our If-Called Yield of 6.26%. We can, for the most part, forget about this strategy then and look to the future. The meteoric rise of CLX this year is mainly due to this defensive-led rally we have seen in the markets. With investors still salivating for yield, and highly skeptical of the markets due to the still poor economic conditions, the large safe dividend names like CLX have helped lead the charge higher for the markets. This has led the consumer staple giant to a 5-year P/E high of 20, what many consider to be expensive for such a slow-growth stock. This obviously leads to the question of why are we buying it if it is expensive?

Because we are looking to get a little defensive at the moment. That might not make sense at the moment, but humor us. Our investing philosophy here is to buy stocks of companies that we want, not for today, not for tomorrow, but for years down the road. While we think timing and valuation are important concepts on deciding when to buy and sell an investment, when you are considering an investment you want to hold for the long-term, these factors become less weighted as compared to how strong the company you are investing in is. Clorox is large, has a substantial cash flow, no debt, low beta, high dividend, and is integrated into the average consumer's life. We already explained why we like Clorox in our last article, and that hasn't changed. So we're going to focus on the strategy this time around, and explain why we believe it is the best one to employ at the moment.

We're looking to sell the October 2013 $85 in-the-money Call. We're looking at an in-the-money Call for a few reasons. Most importantly, because we believe that the markets are getting a bit overvalued, and our steam might be running out, especially in the consumer-staple industry. But we love Clorox, and would rather invest in it than anything else if we want to be in the market yet defensive at the same time. The company missed on their recent earnings report, which resulted in the pullback down below its 50-day moving average. It has now traded below its 50-day moving average for eight days. If the stock can't break above that level, the next technical support level the stock has is its 100-day moving average, which is currently somewhere around the $83 level. This means that the stock can drop down to that level without much effort, until it bounces against that average. If the stock drops down to $83, we have still made a profit from the sale of our Call, and get to hold on to a stock we are happy to have in our portfolio ad infinitum. If the stock ends up breaking through to the upside, then we have received a substantial premium from the sale of our Call, and have a defensive "bond-like" investment - which we think is a more suitable investment given the current market. So an in-the-money Call seems to be more prudent considering the current market conditions, recent earnings report, and technical support. That is why we are recommending buying Clorox and selling the $85 in-the-money Call.

Scenario:

• Buy 100 shares of CLX @ $86.04 = $8,604 + Commission ($12.95) = $8,616.95
• Write 1 CLX October 2013 $85 Call @ $340 - Commission ($8.70) = $331.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.

(3.31 + (0.64))/86.16 X (365)/160

= 10.46% Static Return

(3.31 + (0.64) + 85 - 86.16)/86.16 X (365)/160

= 7.39% If-Called Return

Posted by OaktreeAdvisors at 5/13/2013 9:51 AM
Categories: Weekly Picks

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Disclosure: I am long CLX.

Additional disclosure: At OakTree we are active managers and own CLX and have written calls options on some but not on all shares of CLX.

05/06/13 Covered Call Pick: Walt Disney Company (DIS)

The Walt Disney Company (DIS), commonly referred to as "Disney", is the world's largest mass media conglomerate by revenue, not only operating a host of studios and media channels, but their iconic theme parks and resorts. Founded in 1923, the company quickly became the leader in American animation industry with their iconic characters, like their mascot Mickey Mouse, recognizable around the world. Most known for animation and film studios, Walt Disney Studios and Pixar, the company also owns the ABC broadcast network, channels such as The Disney Channel, ESPN, A&E Networks, Lifetime, and ABC Family. They also acquired Marvel Studios in 2009, and Lucasfilm just last December, making them one of the largest, and arguably the strongest, media content provider in the world. They also license, publish, and sell a host of toys and products based off of their characters and content.

The Walt Disney Company has a market capitalization of $116.99 billion, with 1.805 billion outstanding shares.

The Walt Disney Company currently pays an annual dividend of $0.75 for a current yield of 1.2%.

With a beta of 0.91, DIS trades with approximately 10% less volatility than the current market.

Honestly we're not sure what else we really need to write here after you read that opening paragraph, but we'll give it a shot.

As you might have noticed, we're a big fan of searching for and recognizing trends in the global marketplace. The past few weeks our recommendations have involved two medial devices companies, recognizing the upcoming demographic shift that will cause these companies to become more profitable. Another trend we have recognized and discussed numerous times, is the move to mobile computing. People are using portable devices such as tablets and smartphones to do their computing and access the internet. That has been talked about at length, by us and by many others in our industry. What we haven't discussed yet, is what all these people are doing with their mobile computing. Far and above, the answer more often than not is: consume content. While some use their devices for work, because of how pervasive and integral the technology is in the modern household now, the average person uses their technological devices (mobile or not) for content consumption. It stands to reason then, the companies that control the most and the best content will profit. That's where Disney comes in.

Gone are the days when Disney was considered "just" an animation company. These guys are huge. Let's start with all the things you might not associate with Disney, but are some of the major reasons you should buy the stock. Some of the most profitable sections of the company most people don't know are under the Disney umbrella. The sports channel giant ESPN arguably has the best pricing power on cable, and receives some of the best ratings from NFL and NBA broadcasts. The A&E channel has some of the most popular and iconic shows on cable with Breaking Bad, Mad Men, and The Walking Dead topping ratings charts. Let's not forget ABC either, which has had recent hits in Revenge and Once Upon A Time. All of this strongly desired content comes out of Disney, and we haven't even gotten to anything that's stamped with Mickey ears yet.

Let's move to movies. The company has over 75 movies to gross more than $100 million in the box office, including the #1 opening-weekend movie of all time in "The Avengers" with $207.4 million. Their most recent hit is last week's "Iron Man 3" which came in at $175.3 million in the U.S. for the weekend, putting it in second place. The acquisition of Marvel Studios by Disney in 2009 has been a huge boon to the company, as the character and plot structure of the comic-book based world the studio builds their movies off of allows for greater audience investment as their favorite characters become intertwined in the cinematic world. The company paid $4.2 billion for Marvel studios in 2009, and the revenue generated from "The Avengers" ALONE paid for the acquisition. With a host of movies in the works out of Marvel Studios in the next five years, including "Avengers 2", the acquisition is looking to be one of the most profitable for a media company in a long time.

Speaking of acquisition, this past December, the company acquired Lucasfilm and thus the ability to tap into and extend perhaps one of the most iconic franchises in the history of cinema: Star Wars. With the first new Star Wars movie slated for 2015, we can't even begin to conceive of the possible boon this acquisition will have for the company, but we know its going to be big.

Oh, and they also own Disney and Pixar studios, the two most profitable animation companies in history. So there's that.

Here's what ties all that together. The company is able to monetize and market all of this wonderful desirable content through their theme parks, toys, video games, and product lines. While generally a huge expense on their bottom line, their parks act like huge interactive advertising campaigns that market their content across a surprisingly wide range of age groups. This more than makes up for the enormous operating costs of the theme parks as they pervade the sensibilities of their target audiences. Being able to go to an amusement park and interact with your favorite characters and storylines is not something to be overlooked, and is obviously a huge draw for younger audiences.

We can talk about the strength of the Disney content umbrella all day (like the deal with Netflix that is helping expose its content to children, and ties in with our initial comments about mobile content) but now its time to talk about the stock. Some say the company is expensive with a P/E of 21, but this is actually a 20% discount to the industry average of 26.4. While the company's price-to-sales, and price-to-book ratios are at a premium to the industry, these are due to the high operating costs of its theme parks and cruise ships, which we have already mentioned end up being a net positive for the company in the end. Analysts also expect a 13% increase in earnings per year for the next 5 years off of the strong content coming out of Pixar, Marvel, and Lucasfilm studios, so there is a tremendous amount of growth potential for the stock.

For a Covered Call Strategy we're looking to sell the July 2013 $70 Call. The reason for such a short duration on our Call is that the stock only pays a dividend once a year in December. That means you're not getting paid to hold on to the stock till the end of the year comes around. To help generate yield, while still having access to the growth potential of the stock, we'll be looking to generate quarter-like dividends by selling out-of-the-money Calls. This requires a bit more active management, but we believe will create better returns in the end. While the premium for the Call, repeating it multiple times throughout the year will yield a better annualized yield than the S&P 500. Also note, that while DIS reports earnings tomorrow, and generally trade down in reaction to reporting whether the results are positive or not, we see that as just another opportunity to add to the position. That is why we are recommending buying DIS and selling the July 2013 $70 Call.

Scenario:

• Buy 100 shares of DIS @ $64.61 = $6,461 + Commission ($12.95) = $6,473.95
• Write 1 DIS July 2013 $70 Call @ $59 - Commission ($8.70) = $50.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.

(0.50)/64.74 X (365)/75

= 3.76% Static Return

(0.50 + 70 - 64.74)/64.74 X (365)/75

= 43.30% If-Called Return

Posted by OaktreeAdvisors at 5/6/2013 10:14 AM
Categories: Weekly Picks

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Disclosure: I am long DIS.

Additional disclosure: At OakTree Investment Advisors, we are active managers and own positions in DIS and have written Covered Calls on some of our long positions.