Living in the U.S., especially on the West Coast, I was under the impression that smoking was on its way out. Boy, was I wrong.
I recently went to Europe and the Middle East and people still smoke heavily. Even friends of mine, who didn’t smoke before, now all engage in a form of social smoking — every get-together has a few sessions of smoking.
So what I thought was a dying breed, tobacco companies have nothing to fear. This is especially true for Philip Morris International Inc. (NYSE:PM) since it engages global sales outside of the U.S. where business is booming.
Sure, alternative cigarettes are a threat. There’s a “vape” store on every corner, even in Southern California where I live. But I think these recruited new smokers and did not convert current nicotine smokers to vaping. So while the electronic cigarette sales rise, it’s not at the majority expense of traditional cigarettes.
From a fundamental perspective, Philip Morris’ price-earnings ratio of 26 is not bloated, but it is on the high side. Also the company has a habit of disappointed on earnings.
This morning, Wall Street did not like its report, which sent PM stock down near $118 per share. This doesn’t change things for the mid-term, so I want to take advantage of this dip to generate income.
The idea is to sell risk against what others fear and collect a premium for potential income. The trick is to find support levels that are likely to hold. Because if price breaches my risk then I must own temporarily Philip Morris stock at that price.
Click to Enlarge Technically, PM is still elevated and even after this morning’s dip I would still be chasing the stock after a 30% rally in seven months. Furthermore, $116 and $112 per share are pivotal and would need to hold else the bears could retest $111 next.
So I will set today’s risk well below these levels just to be safe. I will aim for a 15% buffer from current price especially since the general equity markets are at all-time highs.
The Bet: Sell PM Dec $100 put and collect $1 per contract. This opens my risk, so I need price to stay above my strike. Based on today’s data, I have a 90% theoretical chance of complete success.
If price falls below it, however, then I must own the shares and suffer losses below $99. In this case and with a buffer of 15%, I accept the worst-case scenario where I have to temporarily own PM shares at $100.
Those who do not want wide risk profile of a naked put can sell a spread instead. There I buy an equal count of puts, but lower than the ones I sell.
The Alternate Bet: Sell PM $105/$100 bull put spread where I have near the same odds of success, but with a fraction of the risk. If successful, the spread still delivers 12% yield. This setup carries less risk than the naked put, because it is self-hedged, and the maximum loss is finite.
Still, investing is dangerous, so I never bet more than I am willing to lose.
Learn options as easy as 1-2-3 here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
