Why I'm Buying LEAP Call Options On Ford, Alcoa, Citigroup

Includes: AA, C, F
by: Kevin M. O'Brien

While I am for the most part a short-term options trader, I occasionally buy long-term LEAP call options (also known as Long-Term Equity AnticiPation Securities) on a company that I feel represents great value. I am especially cautious when I go this route as I must have complete confidence going forward that the stock will have a considerable move upward within a full year time-frame. Some of the names that I currently hold long-term options with are EMC Corp (EMC), Cisco (NASDAQ:CSCO), Apache (NYSE:APA), and Apple (NASDAQ:AAPL).

I am planning to open up/add new positions with the following companies this week using call options that expire in January 2013. Generally, I will only initiate a position when a certain stock is near its 52-week low and also well below its 52-week high. This is a statistic that I feel limits risk and ensures profitability.

For this article, I will explain why I like these stocks and what price the stock could be trading at in the given time-frame. Whether you go long the stock or use call options, these names should provide very healthy returns. Let's get to my picks.

Ford Motor Co. (NYSE:F)

F primarily develops, manufactures, distributes, and services vehicles and parts worldwide. It operates in two sectors, Automotive and Financial Services.

Ford is currently trading at $9.75/share. The 52-week range is $9.05 - $18.97.

52wk high: 18.97
52wk low: 9.05
EPS: 1.66
PE: 5.90
Div Rate: N/A
Yield: N/A
Market Cap: 37.05 B
Volume: 20.12 M

Currently trading at the very low-end of its 52-week range, I feel F represents tremendous value here if you are willing to be patient. There is a lot of room for the stock to move upward. I already own call options that expire in April 2012, but I will be rolling these over to January 2013. The stock was on a bullish run from about October 6th- November 14th, but the recent slide in the markets sapped a lot of the positive momentum that it had. This is why I feel it is an ideal opportunity to enter a position at its current price.

Stock Price History
Beta: 2.28
52-Week Change3: -39.29%
S&P500 52-Week Change3: -2.45%
52-Week High (Jan 13, 2011)3: 18.97
52-Week Low (Oct 4, 2011)3: 9.05
50-Day Moving Average3: 11.20
200-Day Moving Average3: 12.02

Even the lowest consensus estimates have F trading well above its current price.

Price Target Summary

Mean Target: 16.69
Median Target: 15.00
High Target: 24.00
Low Target: 14.00
No. of Brokers: 13

Looking at the past year of analyst upgrades and downgrades for the company shows that at $9.72, F is still very undervalued:

18-Aug-11 Reiterated Barclays Capital Overweight $20 → $15
19-Jul-11 Initiated RBC Capital Mkts Outperform $19
27-Apr-11 Reiterated UBS Buy $20 → $22
31-Jan-11 Reiterated UBS Buy $21 → $20
10-Jan-11 Reiterated UBS Buy $19 → $21
10-Jan-11 Reiterated Barclays Capital Overweight $17 → $23
28-Oct-10 Reiterated Barclays Capital Overweight $16 → $17
27-Oct-10 Reiterated UBS Buy $16 → $18
27-Oct-10 Reiterated Barclays Capital Overweight $16 → $17
14-Oct-10 Upgrade Deutsche Bank Hold → Buy $14.50 → $19.50
16-Sep-10 Upgrade Barclays Capital Equal Weight → Overweight $15 → $16

At some point during the next year, F will be at least 30%-40% price-per-share higher than what it is now. When this happens, I would recommend selling, as F does seem to have an issue keeping a price level near its 52-week highs.

I would also recommend adding to an existing position on any downturn with the stock to average down and lower your cost basis. I frequently will do this with CSCO and other stocks.

Ford has also beat consensus earnings estimates three quarters in a row. Here is their past EPS numbers and future estimates:

While the stock price is cheap enough, the January 2013 $12.50 call options have a current bid/ask spread of $0.90-$0.91. Anything below $1.00 is a good buy, which is paying less than 1/10 of the share price. The stock was trading above $12.50/share as recently as October 25, 2011 and the those call options would skyrocket if the stock recovers soon to that level. This is a very low-risk trade in my opinion.

F has a current beta of 2.28. The short-interest is at 3.90%. Ford's next earnings release is preliminary scheduled for January 24, 2012.

Alcoa Inc. (NYSE:AA)

AA engages in the production and management of aluminum, fabricated aluminum, and alumina. The company operates in four segments: Alumina, Primary Metals, Flat-Rolled Products, and Engineered Products and Solutions.

AA is currently trading at $8.95/share. The 52-week range is $8.45 - $18.47.

52wk high: 18.47
52wk low: 8.45
EPS: 0.95
PE: 9.40
Div Rate: 0.12
Yield: 1.3408
Market Cap: 9.53 B
Volume: 13.05 M

AA is another stock I've had my eye on for a while now. I have held off purchasing any call options until I felt the price hit a low enough level where I felt there was minimal downside left. That time is now.

Like F, AA is very close to its 52-week low and well off its 52-week high, which is exactly what I look for. A volatile stock, AA could make a very quick rebound in a short amount of time. As recently as October 27, 2011, AA was trading at $11.48/share.

Stock Price History
Beta: 2.01
52-Week Change3: -32.66%
S&P500 52-Week Change3: -2.45%
52-Week High (Apr 8, 2011)3: 18.47
52-Week Low (Oct 4, 2011)3: 8.45
50-Day Moving Average3: 10.20
200-Day Moving Average3: 12.98

Steel stocks in general have all been hit very hard by the economy and market conditions, and this includes stocks such as United States Steel (NYSE:X), Arcelor Mittal (NYSE:MT), AK Steel (NYSE:AKS), and Nucor Corporation (NYSE:NUE). When the economy and markets improve (and it will happen sooner rather than later), you can guarantee that AA will not be trading at this low price.

Analysts have the following price targets for AA:

Price Target Summary

Mean Target: 13.27
Median Target: 13.00
High Target: 18.00
Low Target: 9.75
No. of Brokers: 14

Here is a list of the upgrades/downgrades AA has received over the last year:

18-Oct-11 Initiated Stifel Nicolaus Buy $13
09-Sep-11 Reiterated UBS Neutral $16.25 → $13
12-Aug-11 Upgrade BMO Capital Markets Underperform → Market Perform $15 → $14
12-Apr-11 Reiterated UBS Neutral $18 → $19.50
12-Apr-11 Downgrade BMO Capital Markets Market Perform → Underperform
14-Jan-11 Upgrade Dahlman Rose Hold → Buy $22
12-Jan-11 Reiterated Barclays Capital Equal Weight $15 → $17
11-Jan-11 Reiterated UBS Neutral $17 → $18
11-Jan-11 Downgrade RBC Capital Mkts Sector Perform → Underperform $15 → $16
03-Jan-11 Upgrade Deutsche Bank Hold → Buy $14 → $22
11-Nov-10 Downgrade BMO Capital Markets Outperform → Market Perform

Since AA is a volatile stock, you must be willing to withstand the ups and downs. However, I feel AA is very near hitting a bottom in regards to its stock price.

I would recommend buying some January 2013 $12.50 strike call options. The current bid/ask spread is $0.86-$0.91 and reasonable. This will most likely be another circumstance where you will be able to sell well ahead of the expiration date and make a profit, so I would not hesitate doing this when that time comes.

Here is their past EPS numbers and future estimates:

Alcoa's next earnings release is preliminary scheduled for January 9, 2012.

Citigroup, Inc. (NYSE:C)

C is a global financial services company, provides consumers, corporations, governments, and institutions with a range of financial products and services.

Currently, C is trading at $23.63/share. The 52-week range is $21.40 - $51.50.

52wk high: 51.50
52wk low: 21.40
EPS: 3.72
PE: 6.40
Div Rate: 0.04
Yield: 0.169276
Market Cap: 69.09 B
Volume: 28.17 M

Just like the first two names on this list, C has been absolutely hammered the last two and a half weeks. As recently as November 9th, the stock was trading over $30.00/share.

The stock is now a little over $2.00 from its 52-week low of $21.40/share. C actually provides the largest upside of the three stocks on my list, but the EuroZone situation may cause it to take more time than the other two because this is a financial stock. However, if that situation is somewhat resolved or even stabilized, C will most likely recover very quickly, and the stock will move up fast.

C is long past the problems it had in 2008, unlike Bank of America (NYSE:BAC). While BAC offers tremendous upside, it is extremely risky to own right now. Both Citigroup, Wells Fargo (NYSE:WFC), and JP Morgan Chase (NYSE:JPM) offer much more security and will have you sleep better at night.

With 22 analysts covering C, the consensus price targets are as follows:

Price Target Summary

Mean Target: 43.86
Median Target: 45.00
High Target: 55.00
Low Target: 28.00
No. of Brokers: 22

Here is a quick summary of the upgrades and downgrades C has received over the last year:

18-Oct-11 Reiterated RBC Capital Mkts Outperform $52 → $46
18-Oct-11 Reiterated Barclays Capital Overweight $55 → $50
10-Oct-11 Reiterated Oppenheimer Outperform $45 → $43
07-Sep-11 Reiterated Oppenheimer Outperform $56 → $45
18-Jul-11 Reiterated Oppenheimer Outperform $55 → $53
18-Jul-11 Reiterated Barclays Capital Overweight $60 → $55
21-Jun-11 Initiated Standpoint Research Buy $55

The January 2013 call options are what I'm looking at now. They do seem priced for a rebound in the stock, but this is still the safest way to play C using LEAP options.

Instead of purchasing the stock, I would recommend buying the January 2013 $23.00 call options, which currently have a bid/ask spread of $7.00- $7.25. This makes sense since C has a pathetic dividend of only $0.04. Because these $23.00 January 2013 strikes are at-the-money currently, you will be riding the upward move in the underlying stock at a discount.

C has also beat the consensus EPS estimates for three quarters in a row, which a positive sign that they are stable. Here is a look at their past EPS numbers and future estimates:

C is preliminary scheduled to report their next earnings on January 18, 2012.

Disclosure: I am long CSCO, EMC, AAPL, F.

Additional disclosure: I have long call options in F currently, but will be adding January 2013 calls (LEAPS), I also will be adding long call LEAP positions with (C) and (AA)