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Derisking But Staying In The Game

|Includes: ENTG, Hartford Financial Services Group Inc. (HIG)

Speculative value can be problematical during market declines. My position in Hartford Financial (NYSE:HIG) has been developing poorly, and a review of its behavior during the 2008-2009 crisis makes it suspect if the going gets really ugly over the next several months.

Meanwhile, I saw an article by ZetaKap, a screen directed at companies that have high quick and current ratios, and are trading at low P/E's. Of the six stocks mentioned, I own two - Corning (NYSE:GLW) and Power One (NASDAQ:PWER). I previously owned another - Entegris (NASDAQ:ENTG) - briefly but profitably.

I wrote the stock up favorably at the time, mentioning a diagonal call spread which proved to be profitable.

Today, with shares at $7.56, I did the following vertical call spread on ENTG:

Sold 10 ENTG Nov 17 2012 7.5 Call @ 1.02

Bought 10 ENTG Nov 17 2012 5.0 Call @ 2.82

At a net debit of $1.80, there is a profit of 70 cents if the stock stays above $7.50, for an IRR of 85%. Break-even is $6.80. With implied volatility at 51.09%, there is a nice combination of volatility and margin of security, due to the excess of current assets over and above what is required to operate the business in a prudent and orderly fashion.

Three year average EPS is 73 cents. Applying a P/E of 12, I get $8.76, to which I add $2.32 for current assets above a 2:1 current ratio, arriving at a target price of $11. The 52 week high is $10.58.

I also closed out a diagonal call spread on HIG, locking in a loss. I completed my transaction log for the trade, finding that I lost money at a -43.8% IRR. While painful, the options trade hurt far less than would have been the case if I had owned the shares. It amounted to $5.15 per share controlled, compared to $13.01 I would have lost by owning.

This type of switch makes sense to me. You don't have to get it back where you lost it. At (or near) market bottoms, there are many undervalued situations, and they aren't all created equal.

Disclosure: I am long HIG, ENTG.

Additional disclosure: While I closed out the HIG diagonal call spread, I'm still holding some TARP warrants, which are easier to manage in a down market.