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Buy CBOE Holdings (CBOE) And Sell A Covered Call

|Includes: CBOE Holdings (CBOE)

02/10/14 Covered Call Pick: CBOE Holdings Inc. (NASDAQ:CBOE)

CBOE Holdings Inc. (CBOE), or the Chicago Board Options Exchange, operates a global options exchange that integrates open outcry methods and electronic platform ordering into a single market. The CBOE is the largest U.S. options exchange offering options on well over 2,200 companies, 22 indices, and 140 ETFs.

CBOE has a market capitalization of $4.66 billion with 87.2 million outstanding shares.

CBOE currently pays a $0.18 quarterly dividend for a current yield of 1.3%.

With a beta of 1.15, CBOE currently trades with approximately 15% more volatility than the current market.

Last summer we first introduced you to a Covered Call Strategy on CBOE. For many of you it was probably the first time you heard of investing in an exchange as a company. The strategy ended up getting called away in December for an If-Called Yield of 17.42%. Now we're looking to get back into CBOE based upon recent technical confirmation and recent fourth quarter performance.

CBOE recently reported Q4 earnings of $0.52 EPS and revenue of $141.8 million. That is a 16% y/y increase on earnings while revenues rose 9%. This performance mainly stems from the 9% increases in transaction fees throughout the quarter, driven by CBOE's exclusive product lines. The exchange provides index options and futures, with both categories seeing increasing attraction from investors. Index options volume rose 15% last year while futures volume rose 27%. As options have become more and more popular (the sheer existence of this blog being evidence) with investors, and accessibility to options education, information, and platforms have increased, CBOE has profited from being the biggest name in the game. While the number of competing exchanges in CBOE's space have double since 2007, CBOE's exclusive license to trade options on the S&P 500, an agreement recently extended through 2032, has given it lasting competitive power and a strong profit driver. Options on indexes like the S&P 500 allow investors low cost exposure to the broad marketplace, and since options on indexes earn higher fees than other options products, they constitute a large revenue driver for CBOE.

Technically, CBOE's stock just recently broke out. This comes after a double bottom, which is a technical chart formation when a stock price drops, rebounds, the drops again, followed by a second, larger rebound. This creates a 'W' chart formation, and if the stock's second rebound does not sputter out, is a strong bullish indicator towards the upside. The thesis behind this is that the stock is initially sold at the top due to being too expensive. You then have an initial rebound when the quick money gets in to grab a buck on the "buy on the dip" mentality. This fades quickly as they grab their fistful and get out the door, leading to another dip. This second dip can create a technical support level, as now the smart money comes in as fundamental value has begun to catch up to the stock price. This creates a rebound that, when others catch on, helps propel the stock higher. In CBOE's case this is combined with a better than expected Q4 report which let the stock break past its previous resistance level at $53.52 and on to new highs, which is bullish support for the stock.

For a Covered Call Strategy on the stock, we are recommending the June 2014 $57 Call based on the fundamental and technical reasons reported above. Even though the markets might still struggle over the next few months, we believe that the low cost market exposure that CBOE offers through its index options, and the increasing volatility in the market that can be accessed through their VIX futures options will make the exchange a draw in the already volatile 2014 market. That is why we are recommending buying CBOE and selling the June 2014 $57 Call.


  • Buy 100 shares of CBOE @ $54.18 = $5,418 + Commission ($12.95) = $5,430.95
  • Write 1 CBOE June 2014 $57 Call @ $140 - Commission ($8.70) = $131.30

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

(1.31 + (2*0.18))/54.31 X (365)/130

= 8.63% Static Return

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

(1.31 + (2*0.18) + 57 - 54.31)/54.31 X (365)/130

= 22.54% 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 Oaktree Advisors at 2/10/2014 11:12 AM
Categories: Weekly Picks

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Disclosure: I am long CBOE.

Additional disclosure: As active managers, OakTree Investment Advisors may increase or decrease positions recommended as markets dictate.