Trading vs. Investing Using Options HPQ Revisited
The jobs market can breathe a sigh of relief today knowing that the unemployment rate dropped .3 of a percent to 7.8%. I am trying to remember the last time the percentage drop was that big, but it was quite an achievement considering the jobs numbers have been pretty anemic for months. For sure it has not happened in the last year (see my chart). My only guess is the employers were relieved that the Euro Crisis was solved and got hiring. I hope this is the start of a great trend, but of course, we will have to wait for confirmation next month.
This brings me to my main topic of trading versus investing and taking a long term view. This week, I put up a post on HPQ as the name fights to right the ship after several years of miscues. As a trade, that diagonal time spread was a nice short term play on selling the near term activity with controlled risk (still looks ok). But what if you are an investor and want to use options for the long haul? What if you are stuck with a position in HPQ and don’t want to take the huge loss?
HPQ was a $79 name that just spun off Agilent in 2000. At the time, it was trading at 30x earnings like most of the other big cap technology names riding the internet boom. Now HPQ trades at 7x reduced earnings next year. The company has front loaded lots of bad news, so it can create an easy bar to leap over when the future ticks up. The problem is things are going to take time to correct. At least a year if the CEO is accurate in her assessment. For investors down at this level siting on a bunch of stock, what the heck do you do? This is a problem that I was covering with one of my mentoring students.
It is time to use the leverage of options to your advantage. Dump some percentage of the stock and buy some leaps. A 1000 share sale would net around $15000 right now and create some losses to write against some gains. Our hypothetical investor could buy 60 HPQ JAN 2014 15 level calls for $2.5 and generate 3x the upside power (eventually 6x), if they decided to go all in with the proceeds from the sale. Even a 20 lot would give the investor the same delta but ultimately twice the long exposure from any upswing in the price for only $5000. There are plenty of ways to reduce the dollars at risk but increase the upside exposure using different amounts of calls (or puts to really leverage). The secret here is using time to correctly pick the options. The time frame for the turnaround is long, so the cycle to choose as an investor is long too. With the new leverage, the investor can start writing a couple extra calls against the position to make up for those missed dividends.
In the options world, this is known as stock replacement, and when HPQ sees $20 in the next year and half, it is also known as making new money with the old money.
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