Dark Horse Traders' Hedge: Ride Sally Ride (SLM) in Option Review, Add Cooper Tire (CTB)

Mustang Sally

Guess you better slow your Mustang down

Mustang Sally

Baby, I guess you better slow your Mustang down

You been a runnin’ all over town

I guess I’ll better put your big feet on the ground

Oh, yes I will

All you wanna do is ride around, Sally

(Ride Sally ride)

All you wanna do is ride around Sally,

(Ride Sally ride)

Buddy Guy

In our last article (September 8, 2012), we commented on the likelihood that the United States would follow the ECB in implementing a form of QE3, which in fact happened.  It happened with such a magnitude that many “experts” have given the impression that Fed Chairman Bernanke “better slow (his) Mustang down.” The argument for or against QE3 is best left for another day, but I believe it is safe to say that the re-opening of the printing machine will help prop the market up in the short term, allowing us to make safer additions to our Dark Horse Traders’ Hedge long positions.

SLM Corporation (SLM) or Sallie Mae, was recommended on June 25, 2012 at $14.95 by acquiring half the desired number of shares and selling the Oct ’12 $16 call (+$.55) and Oct ’12 $16 put (+$1.95).  Incidentally, we also picked up a $0.125 dividend on September 20, 2012. 

Having watched the first Presidential debate of 2012, it was obvious that both candidates support education, and that is the sweet spot that SLM engages in by originating, acquiring, financing or servicing private education loans.  Combine this with our new $40 billion per month printing machine, and I think we can safely recommend that we “Ride Sally ride” for another quarter. 

With nine trading days left before expiration, we should buy to close our current October positions and sell to open January 2013 at a higher strike, $17.50. The result will be spending $0.85 to buy to close the Oct $16 call and $0.15 to buy to close the Oct $16 put, allowing us to earn $1.50 plus the $0.125 dividend while holding our position in SLM which traded from $14.95 – $16.77.  Now we can sell to open the Jan ’13 $17.50 call for $0.63 and the Jan ’13 $17.50 put for $1.47, bringing in another $2.10 plus another dividend while hoping SLM trades right up to $17.50 between now and January.

I feel good enough about the current valuations and support offered by the money printing machine (QE3) to add a new long position.  Cooper Tire and Rubber Co. (CTB), is another company that fits the mold for the Dark Horse Traders’ Hedge portfolio.  CTB has achieved earnings growth in 2012 of 87% by consistently delivering large earnings surprises.  Analysts are expecting another 17.3% of EPS growth in 2013, and we can acquire that future earnings growth for a forward P/E of 6.4.  Now you’re talking my kind of math. CTB also has free levered cash flow of $62.5 million (not great, but enough to pay a forward dividend yield of 2.1%).

Like most other positions, we will recommend acquiring half the desired shares for $19.13 and simultaneously sell to open the Feb ’13 $20 call for $1.30 and Feb ’13 $20 put for $2.25. This brings in over 20% in four months on a stock we feel we are buying cheap.  Of course, we hope to make more than the 20% because the plan is to roll these options around February to a future month and strike for more time premium. 

So, “Ride Sally ride” for another three months with SLM and bet on Cooper Tires as “Mustang Sally” is “runnin’ all over town” making us money.

Recommendations:

Buy to close SLM Oct $16 call (SLM121020C00016000)

Buy to close SLM Oct $16 put (SLM121020P00016000)

Sell to open SLM Jan ’13 $17.50 call (SLM130119C00017500)

Sell to open SLM Jan ’13 $17.50 put (SLM130119P00017500)

Buy half desired position in CTB

Sell to open Feb ’13 $20 call (CTB130216C00020000)

Sell to open Feb ’13 $20 put (CTB130216P00020000)