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Go Long Goodyear Tire & Rubber And Hedge With A Call Option

|Includes: Goodyear Tire & Rubber Co. (GT)

12/30/13 Covered Call Pick: The Goodyear Tire and Rubber Company (NYSE:GT)

The Goodyear Tire and Rubber Company manufactures a variety of automobile and other vehicular tires including those for cars, trucks, SUVs, racing cars, airplanes, and heavy earth-moving machinery. The company is the most successful Formula One tire supplier, and is known the world over for their iconic Goodyear Blimp. The company also owns the brand names of Dunlop and Fulda, and operates a chain of tire installation and auto repair stations throughout the United States.

The Goodyear Tire and Rubber Company has a market capitalization of $5.81 billion with 246.9 million outstanding shares.

Goodyear currently pays a quarterly dividend of $0.05 for a current yield of 0.8%.

With a beta of 2.58, GT trades with roughly 2.5 times the volatility of the current market.

For the last article of the year, we're recommending Goodyear - a stock that falls into that outlier category for us in that it is a riskier stock with next to no dividend yield. But while it is riskier than our normal stocks, that risk translates into higher growth for the company, and we believe a good picture for the stock price in the near-term.

The basis of our future prediction starts with the company's most recent performance. For the third quarter, GT posted fantastic results with net income up 51% year-over-year, a record increase for the company. The company cited accelerating tire volume for the remainder of 2013, and believes the trend will continue into the first half of 2014 as well.

While not a traditional bellwether stock like CAT, DOW, or FCX, Goodyear does have its ties to the performance of the economy. GT makes tires for large equipment vehicles like the building-sized earth movers that are used in construction and land clearing for buildings, roads, tunnels, and mines. They also manufacture tires for airplanes, and large tractor-trailers that haul millions of tons of goods around the country every year. Last, but not least, they make tires for the average consumer vehicle, the one that we drive to work everyday.

So if tire volume for GT is accelerating, that means there are more large equipment vehicles that are operating, which means more construction and infrastructure. It means they're putting more tires of airplanes, a huge manufacturing industry. It also means more tractor-trailers are out on the roads, shipping goods across the country more frequently. And it also means more cars are being made and then bought by the average consumer. All of this relates to better economic growth; stronger industry, more manufacturing, more jobs, and more consumption. Being able to look at the world around you and translate what you see into how it will affect a company and its stock, and vice-versa being able to take quarterly reports and trace how it affects us on an economic scale, is what we've tried to do here all year, as we believe that only by making these connections can one really understand their investments. We believe, like many others, that while 2014 will be a decent year for the stock market, what we will really see is true economic growth return to the United States. In this case, we believe that growth will help drive further gains in Goodyear.

For our Covered Call Strategy on GT, we're recommending the July 2014 $26 Call. This strike price allows us to capture some upside potential we believe to be present in the stock due to its increasing performance a better economic outlook, while giving us some downside protection and a mock-dividend-yield better than the current one GT is providing. That is why we are recommending buying GT and selling the July 2014 $26 Call.

Scenario:
 

  • Buy 100 shares of GT @ $23.20 = $2,320 + Commission ($12.95) = $2,332.95
  • Write 1 GT July 2014 $26 Call @ $135 - Commission ($8.70) = $126.30

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


Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

(1.26 + (2*0.05))/23.33 X (365)/201

= 9.91% Static Return


If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

(1.26 + (2*0.05) + 26 - 23.33)/23.33 X (365)/201

= 31.37% If-Called Return


Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

Posted by OaktreeAdvisors at 12/30/2013 10:53 AM
Categories: Weekly Picks

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Disclosure: I am long GT.

Additional disclosure: As a private wealth manager we may increase or decrease our position in GT.