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GE:  A Way To Play The Loathing Of This Name


GE had been a highly respected corporate name for nearly 100 years from the days of Edison and Morgan through the tenure of Jack Welch and Jeff Immelt.

Having had nine President/CEOs in their first 125 years since 1892, the company is now on their third in three years, strongly suggesting serious problems within the company.

At $11.56/share as I write, it is at a low price for the past twenty years, exceeded only by the post-financial crisis lows hit in Jan-July 2009.

Looking through the coverage of this name on Seeking Alpha and elsewhere, the majority view of this once great name is overwhelmingly negative.

With additional bad news pressing down on this name, but it repeatedly bouncing off of the $11.27-$11.29 low and owning some strong businesses to provide fundamental support, I am selling at-the-money put options on this beaten-down name.

Author's Note: This article is intended for investors oriented towards value-deep, value-distressed asset investing. Those seeking moderate- to high-risk value investments may have an interest in this article. Investments in this company at any level of the capital structure are unsuitable for those seeking retirement income, and I strongly discourage purchase of securities related to this company for retirement income accounts where a focus on risk aversion should be paramount.

General Electric has been considered an exceptional corporation throughout most of its history, with legendary businessman like Thomas Edison and J. P. Morgan associated with this corporation.  In addition, throughout most of its history, leadership has been strong and consistent, with five presidents serving from 1892 through 1958 and four additional CEOs (the last president was also the first CEO) serving in the top executive position from 1958 through 2017.  Unfortunately, the company has had three different CEOs in the past three years (end of Immelt's tenure, a brief stint by Mr. Flannery and now Mr. Culp, who apparently has his hands full).  This sudden turnover of CEOs rightly suggest significant corporate challenges which has been noted in the public coverage of this company, which is overwhelmingly negative.

Not surprisingly, the market price of GE has steadily gone from the upper left to the lower right over the past, having reached a cycle high of $32.88 on July 11th, 2016 and has declined to a cycle low of $11.27 on September 25th, 2018.  It has bounced off of that low again on September 28th, 2018 on sizeable volume, then recovered to $13.61 on October 8th, then declined back to the recent low (but not closing at a lower price) last Friday, October 26th.  In early trading today, it has recovered a bit to $11.53 as I write this note.

In addition to the historic low price of this name, implied volatility is elevated, given concerns about general market conditions, with the CBOE Volatility Index (VIX) quoted at $23.41 as I write, significantly higher than the $111.61 close on October 3rd, 2018.  Elevated VIX implies elevated premium available when options are sold.

The combination of these two factors has prompted me to sell long-dated GE put options at-the-money.  I had sold these options on the last move downward in the stock, but one can now sell 12 strike options, expiring January 2021 for $2.17, securing about 18% of the total value of the stock for insuring the value of this name at $12 until that time. I had earlier sold these puts at $2.08, so one can get a better price today, with the total notional value of the trade equal to about 17% of my portfolio.

At $2.17, the "in-the-money" portion of the put is $0.47 while the extrinsic premium on the option is $1.70.

My decision to put on this transaction is as follows:

a.  While the news on GE is nearly uniformly bad, it has a number of very strong businesses on which it can rely on the future.  I am typically selling puts on companies with far weaker businesses than GE has.  Over time, the market will replace their negative views with a more balanced view of what GE offers, allowing some re-equilibration on the price.  As these puts are at-the-money, one does not need to see much relief to allow the put to expire worthless in 2+ years.

b.  GE faces a number of challenges, including a possible dividend cut and need to continue to rationalize their portfolio after having arguably made an untimely deal to acquire Baker-Hughes.  However, in my view, these issues will have been significantly addressed over the next 2+ years at the point of the expiration of these options and the market view of GE may well have changed as it changes on a number of names through restructuring.

c.  The market price has tested the recent lows three times so it appears to have reached a short-term bottom.  With a book value (for a 125 year old company) of $6.34, the current price (implying a basis of $9.83/GE share at expiration) is approaching a sum-of-the-parts liquidation value for a company that arguably has at least some very strong businesses.  In my view, given another 2 years to sort things out, GE will be trading much higher than $12/share, allowing these puts to expire worthless.

d.  Option premium pricing is very expensive right now, so even if GE stays where it is, as the VIX subsides over the next few months, the option pricing will decline. In my view, we may see VIX spike in the next six months to higher levels, offering even better option pricing, but I expect to see it subside to the mid-teens over a longer period of time to a more typical level (but above the abnormally low $10-ish leve that we had seen in the past few years).

The Position:  Sold short to open $12 strike puts on GE, expiring January 15th, 2021, currently selling at $2.17.

Disclaimer: No guarantees or representations are made. The Owl is not a registered investment adviser and does not provide specific investment advice. The information is for informational purposes only. You should always consult an investment adviser.

Disclosure: I am/we are short GE2115M12 puts.