An Option Strategy on International Business Machines
This week’s spotlight for option opportunities looks at International Business Machines (IBM - Free IBM Stock Report), whose earnings for 2011 are now estimated by Value Line analyst Theresa Brophy at $12.95 a share, which would be an increase of somewhat over 12%. Based on that estimate, the current P/E ratio is 14.0, which is a reasonable valuation in our view. Too, dividend increases, which are traditionally initiated in the second quarter, were 18% and 15% in 2010 and 2011, respectively. The current annualized payout of $3.00 a share yields 1.65%.
The recent news in the financial press that Berkshire Hathaway (BRKB), the investment holding company led by Warren Buffett, has accumulated a 5.4% stake in IBM (equivalent to $11.6 billion) since March, 2011 has reinforced the attractiveness of this equity and our suggested option strategy. A key factor that may well have influenced Mr. Buffett is IBM’s shift from its former commodity businesses, such as personal computers, to consulting services and software offerings, which command relatively high margins and are generally based on multiyear contracts. Other pluses are IBM’s long-standing stock-repurchase program and stellar ratings for Financial Strength and Earnings Predictability.
The stock chart for IBM indicates near-term support and resistance at around $170 and $190 a share. That said, following the jump in the market averages and the share price of IBM on 11/30/11, we’ve increased the suggested strike prices of the puts and calls by $5.00. At this juncture, the cash-covered put with a strike price of $175 and the covered call with a $195 strike price, both expiring on 1/21/12, appear quite attractive. Assuming IBM is above $175 a share at the expiration date, the annualized yield for the put, based on the closing bid price of $2.95 on 11/30/11, is 12.3%. This transaction should particularly appeal to conservative investors. The annualized yield for the call (bid price: $3.15), on an unchanged basis, is 13.5%. (This article was originally published on Value Line’s Options Premium Content page on December 1, 2011).
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.