Bad news tends to dominate the headlines and we often miss the
signs of good news that are buried lower on the page. One example
of good news was theunemployment rate for November falling to 7.7%,
a four-year low.
As people return to work, theeconomy should grow, and that
growthwill benefit a number of companies. Energy companies are
usually among the winners in a growing economy. These companies can
be risky, though, especially if the price of oil falls, but there
are some companies that are diversified energy plays.
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Phillips 66 (
PSX
)
is a diversified energy company. With 15 refineries, Phillips 66
offers a way to benefit if the demand for oil and gasoline rises,
as it would if the economy grows. The company's 10,000 gas stations
and retail outlets would benefit from an increase in the number of
miles driven. And demand and prices of its chemicals will increase
with gains in industrial production. With so many ways to benefit
from growth, Phillips 66 is in some ways a trade onGDP .
Phillips 66 was spun off from
ConocoPhillips (
COP
)
earlier this year and has a limited trading history. The stock does
seem to be undervalued, trading at a price-to-earnings (P/E ) ratio
of about 6, less than half the average of large-cap stocks in the
stockmarket . Earnings are expected to drop next year, but Phillips
66 still looks undervalued with a P/E ratio of 9 based on next
year's expectedearnings . After falling next year, analysts
expectearnings per share (
EPS
) to grow at about 7.2% a year, a number I think we can use to
define afair value for Phillips 66.
Some analysts believe that a stock is trading at fair value when
the P/E ratio is equal to theEPS growth rate, a measure known as
the price/earnings to growth ratio (PEG ). Analysts expect EPS for
Phillips 66 to come in at $6.22 next year. Assigning a P/E ratio of
7.2 to those earnings, the stock would have a fair value of about
$45 a share. I like Phillips 66 as a long-terminvestment and would
like to buy it at $45, and by selling a put I might be able to do
that.
Put buyers expect to see a stock price fall. Put sellers may
think that the stock price will go up or stay the same, or they may
be selling because they are willing to invest in the company at the
right price. Since I believe Phillips 66 would be fairly valued at
$45, I can sell a put at $45 and buy the stock at that price if it
falls about 17%. If Phillips 66 reaches $45 by the time the put
expires, then I'll own a great stock at a fair price. If Phillips
66 does not fall that much, I'll earn income from the premium that
I collect when I sell the put.
January $45 puts are trading at about 28 cents a share. Eachput
option is for 100shares , and selling one put will generate $28 in
immediate income.Brokers allow these types of trades with a
20%margin , or $900 in this case. If the put expires worthless, the
3.1 % income works out to an annualized rate of return of about
27%. If the put is exercised, I believe that Phillips 66 will
deliver a total return of more than 10% a year in the long-term
when the $1.25 a share annualdividend is considered.
Phillips 66 looks like a long-term winner, but it also looks
slightlyovervalued . A put sale creates an opportunity to earn
income while waiting for Phillips 66 to fall to a fair
valuation.
Action to Take -->
Sell Phillips 66 Jan 45 Puts at themarket price . Do not use a
stop-loss. If the puts are not exercised, the premium received will
be a 100%profit ; if they are exercised, then Phillips 66 will be
bought at about 7 times next year's expected earnings.
This article originally appeared on TradingAuthority.com:
This Trade Could be Your Ticket to 27% a Year
Income