IBM (NYSE:IBM) has been in business for over 100 years, reinvesting in and even reinventing itself when necessary to grow into the huge company it is today.
The reason for IBM’s impressive track record of success is its culture of innovation. Its employees have garnered myriad awards, including five Nobel Prizes, and IBM holds more U.S. patents than any other U.S. technology company.
In 2007, IBM laid out a plan for increasing its earnings-per-share from $6.11 in 2006 to $10 in 2010. 2010 earnings came in at an impressive $11.53 per share. This year IBM has laid out another plan for increasing earnings per share to $20 by 2015.
IBM is poised to achieve this growth because it has a competitive advantage: IBM’s clients rely on it so much for their IT needs that it would be too much of a hassle for them to switch to another company.
So, while it is difficult for IBM to lose existing customers, there is also room for growth, as IBM is moving into emerging economies to gain new customers. Last year alone, IBM saw double-digit growth in 40 countries.
However, growth is only half of IBM’s story — the other is value. This is the part that got Warren Buffett’s attention when he made a $10.7 billion investment earlier this year.
The story behind IBM’s value begins with the dot-com bubble, when all tech stocks became overvalued. When the bubble burst, solid companies like IBM were spared from most of the slaughter, and remained slightly overvalued in terms of share price versus intrinsic value.
From 2003 to 2006 IBM’s share price traded sideways while the company grew its intrinsic value closer to its share price. Now the gap is minimal, and share prices are set to rise in tandem with IBM’s growth.
To capitalize on IBM’s growth and value, we want to own the stock and collect some short-term option premium by selling the IBM Jan 195 Calls against the shares.
Selling calls against undervalued stocks is a great way to maintain upside profit potential while managing downside risk in volatile times. This trade makes $8.25 if IBM closes above $195 at January expiration. If this is not the case, the $4.75 received from selling the call is yours to keep and essentially lowers your basis in the stock to $186.75.
Stock/Index: IBM
Stock Price: $191.50
Option Play: Buy-write
Sell: 1 IBM Jan 195 Call @ $4.75
Buy: 100 Shares @ $191.50
Net Cost: $186.75 = $191.50 – $4.75 (Stock – Call)
Breakeven: $186.75 (Net Cost)
Max Profit: $8.25 = ($195 – $191.50) + $4.75 (Short Strike – Stock) + Call Premium
Max Loss: $186.75 (Net Cost)
Call Away % Return: 4.42% = 100 x ($8.25 Max Profit / $186.75 Net Cost)
