Procter & Gamble: Sweet 16

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Julian Close 09/21/2015

Back in the first week of August, I identified a bull-put credit spread on Procter & Gamble ( PG ). While that now seems to have been a generally bad time to make bullish spread trades, PG has held up better than most. The stock price now sits between the bought and sold calls, (placed at 70/72.5) which is not ideal, but as long as PG is over 72.5 a month from now, the trade will work out fine. That is good news, because PG should have a nice tailwind between now and then, for several reasons.

First, the market is still in rebound mode, and unless it regains its all-time highs, investors will likely remain confident (and if the market does regain its all-time highs, well, so much the better.) Another very important reason is the weakening dollar. The trend is significant. Not long ago, with Euro's trading for just $1.05, it looked very much as if parity were on the way. That was one of the biggest reasons why PG suffered a serious revenue decline, as well as a substantial fall in EPS from $3.98 to $3.06 in its fiscal 2015 (now complete).

When the Euro was back up at $1.12 a couple of weeks ago, some bullish analysts suggested PG might regain all the lost earnings in 2016, and since then, the Euro has gotten even more expensive against the dollar. PG is also shedding brands that aren't growing. This tends to make the headlines, as PGs brands are among the most well known and iconic in the world. Most recently, PG sold Duracell to Warren Buffet.

Lastly, PG just hit sweet 16, which is to say that the market turndown, disappointment over the company's fallen earnings and revenue, and general market pessimism combined to lower PG stock to the point that it's projected fye P/E Ratio is just 16.36. That's more like a mining and smelting P/E than a consumer stock P/E. This is Tide, Bounty, Gillette, Pampers, Pringles, etc. that we are talking about, -  they'll bounce back!

As you may have concluded already, all the good news makes PG look like a pretty good candidate for a covered call right now, though I'm not encouraging anyone still in the last trade to double-dip. Stay diverse!

Let's look at the numbers. To make this trade, buy PG stock for $70.19 per share (100 shares, or scale as appropriate). At the same time sell one contract (100 shares worth) of the PG Jan 72.5 call for not less than $1.50 per share. Your initial $70.19 per share debit is offset by a $1.50 per share credit, making your break-even point $68.69 per share. If PG stock is trading at or above $72.50 per share on the day the option expires (01/15/16), your position is assigned , which means the market exercises the option to buy PG stock from you at $72.50 per share. Your target profit, therefore, is the exit price of $72.50 per share, minus your break-even cost of $68.69 per share, or $3.81 per share ($381, on a 100 share trade. Scale as appropriate.) PG should pay a dividend of $0.67 per share in October, so that's an extra $67, making the total profit $448. All told, that's a return of 6.6%. The trade, in this case, could last 120 days, which would make your annualized return a respectable (for comparison purposes only) 20%.

Chart courtesy of stockcharts.com.

Here are your risks: if the stock price does not rise as high as the strike price, it will not be assigned, at which point, the call you sold will expire worthless, though as long as the stock hasn't fallen below your break-even point, you'll still have a profitable trade. If the very worst should happen, and the stock falls below your breakeven cost, you'll simply end up owning the stock with a lower cost basis than if you had bought the stock without selling the call.

You may be noticing, at this point, that none of those outcomes are actually bad . That's exactly why this sort of trade is so popular with wealthy and institutional investors - all investing may be likened to gambling, but when you write covered calls, it's like being the house. This trade is appropriate for investors with diverse portfolios who are willing to accept market-level risks.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Originally published on InvestorsObserver.com

This article appears in: Investing , Options
Referenced Symbols: PG

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