Smithfield Foods Hamming It Up for the Holidays

by Stutland Volatility Group | November 21, 2011 7:45 am

The growing sovereign debt contagion in Europe has cast a shadow of uncertainty over global markets. However, even in these uncertain times, one thing remains clear: people need to eat.

And what is America’s favorite food group? Meat. As the largest pork producer in America, Smithfield Foods Inc. (NYSE:SFD[1]) is in the perfect position to capitalize on this.

In fact, the pork business is not only stable, but it’s poised for significant growth in 2012. The catalyst driving this growth is a surge in worldwide demand, particularly in China.

Pork prices have appreciated strongly in 2011, while one of Smithfield’s biggest costs has declined. As a result, company executives and directors have been buying shares in bulk. And just recently, the company announced that the profit margins in its upcoming earnings would be even wider than previously expected.

At Stutland Volatility Group, our preferred method of gaining bullish exposure to this stock is by selling a put option spread. Due to current market volatility, we want to be conservative by having the ability to profit from both bullish and sideways markets.

A bull-put spread not only allows this, but also allows us to purchase the stock at $21.25 should SFD decline below $22.50 at January expiration. At this price, we find Smithfield a very compelling value and are happy to be buyers.

Should SFD find itself trading below $17.50 at January expiration, this strategy also has a built-in stop-loss that will come into effect. Although we cannot foresee this scenario, we find it prudent to keep our risk hedged and fixed, especially in times like these.

Here are the details on how to make this SFD Jan 22.50-17.50 bull-put trade at current prices.

Stock:   Smithfield Foods (SFD)

Stock Price:   $22.50

Option Play:  Bull-Put Spread

Sell:   1 – SFD Jan 22.50 Put @ $1.60

Buy:   1 – SFD Jan 17.50 Put @ $0.35

Net Cost:  $1.25 Credit [= $1.60 – $0.35]

Downside Breakeven:  $21.25 [= $22.50 – $1.25]

Max Profit:  $1.25 [= Net Credit]

Max Loss:  $3.75 [= ($22.50 – $17.50) – $1.25]

Next Estimated Earnings:  Dec. 8 Before Market Open

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