Philip Morris International Inc. (NYSE:PM) reported earnings yesterday and Wall Street hated it. The stock fell 4%, and what made matters worse is that yesterday we also had a market-wide tizzy that exaggerated the negative reaction in PM stock.
Luckily, coming into this event, PM stock was still up on the year. Even after this 4% dip, it’s still up 19% year-to-date, which is even higher than the SPRD S&P 500 ETF Trust’s (NYSEARCA:SPY) 15%. So today I want to take advantage of this extreme reaction and create income from nothing.
To do this, I need to find bullet-proof support levels in Philip Morris stock.
On the daily chart, PM stock looks like it’s near an obvious support zone. This may be true since $110/108 has been in contention for months, so it should slow the selling down near there. But when I zoom out to a weekly five-year chart, I can clearly see that the downside could be much deeper.
This is not the same as forecasting a crash for PM, but I’d rather be cautious than assume that the support will hold. Luckily, I am using options to set this trade, so I can build a buffer big enough to make room for the more dire scenario.
It is important to note that should price go against my thesis, I am comfortable owning PM shares at a discount.
Fundamentally PM stock is not a screaming bargain, with a price-to-earnings ratio of 25. For perspective, consider that Apple Inc. (NASDAQ:AAPL) sells at an 18 P/E.
This is not the same as saying that PM is overpriced. Management delivers strong margins and pays a hefty dividend, so I am confident temporarily owning shares at a discount. I believe I can manage out of them for a profit if the price goes against my thesis.
Opinions matter to PM stock price action. Analysts expect a lot of the stock. The average price target is $129 per share. Sure this could be upside potential but not if the experts decide to adjust their targets lower to match price reality. The longer Philip Morris stays this low, the higher the odds of negative headlines of downgrades.
Click to Enlarge I live in California where smoking is getting rarer, so it’s easy to assume that the future looks bleak for cigarette companies. But I recently visited several other countries on two continents and it is my impression that the world still loves to smoke.
Besides, I am sure that Philip Morris is already into other areas to make up any abatement in tobacco use.
PM Stock Trade Idea
The Trade: Sell the PM Mar 2018 $95 put and collect $1.50 per contract to open. This is a bullish trade that has a 85% theoretical chance of success. But if the price falls below my strike then I own the shares and would accrue losses below $93.50.
Selling naked puts carries big risk. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the Mar 2018 PM $95/$90 credit put spread where I have about the same odds of winning. If so then the spread delivers 15% in yield on risk and I don’t even need a rally to profit.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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 as @racernic on twitter and stocktwits.
