Options Trading

Alan Brochstein takes another look at medical-device companies It has been almost two years since I first shared my bullish view on the medical device industry on the TradeKing All-Star blog. Since then, the group's performance has generally improved, in some cases significantly. Despite the recovery in prices, with several moving to all-time-highs recently, I still find these stocks to be very attractive value plays, especially for conservative investors. Before reviewing some of the companies that comprise the industry, I wanted to update my bullish thesis. This industry tends to have high margins, reflecting limited competition, strong and productive R&D, good balance sheets and very favorable demographics (aging population). One of the more interesting characteristics is the high international exposure, and many of these companies are growing their emerging market sales quite substantially. I believe recent economic trends have distracted investors who have focused too much on short-term results rather than longer-term opportunities. Here is a table with data on all the medical equipment stocks with market capitalization in excess of $5 billion: [click on the image above to enlarge it]   Please remember that none of these stocks should be considered as recommendations to buy or sell. You should always do your own investigation of the merits of any investment. I sorted the list by P/E, with the companies with the lowest P/E ratios at the top of the list. Before commenting briefly on each of the companies, I want to point out that the group as a whole is outperforming the market so far in 2011, with a median return of 9% and a range of -9% to 41%. The median P/E ratio is at a slight premium to the S&P 500 at 14.9X, but these stocks have traded at much higher ratios historically. I have included the 5-year average to demonstrate this point. I also included dividend information as well for investors who are interested in income. Medtronic (MDT) looks quite inexpensive to me, but there has been some uncertainty due to the sudden departure of the CEO and the hiring of an outsider to replace him. Much of its historical growth has come from acquisitions. I continue to prefer its rival, St Jude (STJ). Covidien (COV) was spun out of Tyco a few years ago and looks to be on track now, recently printing an all-time high. The company is highly diversified. I follow Zimmer (ZMH) somewhat closely. It has suffered from changes in marketing practices that have impacted the hip and knee implant manufacturers. Despite the market's recovery, the stock retains one of the lower valuations in the industry. Johnson & Johnson (JNJ) has certainly suffered from a series of recalls in its consumer products franchise as well as patent expirations in its pharmaceutical division. Medical devices, its largest segment, has faced industry challenges but seems to be performing relatively well. The stock recently moved to a two-year high and is within 10% of its all-time high set in 2008. St Jude (STJ) remains one of my favorites in the group despite increasing from $33 when I profiled it in the original blog post. The company, with primarily a cardiac/cardiovascular focus, has exceptional management and a robust pipeline of new products. It has pulled back somewhat sharply after posting an all-time high in April. Baxter (BAX), whose products are focused on blood treatments and monitoring, had a couple of major setbacks last year, but that looks to be behind them now. Becton Dickinson (BDX), which is focused on hospital infection prevention and diabetes care, has performed well and is sitting just beneath its all-time high. I used to follow Hologic (HOLX) more closely and should probably take a closer look. They are focused on various aspects of women’s health, including breast and gynecological diagnostics.  I recently added Carefusion (CFN) to my watchlist. It was spun out of Cardinal Health (CAH) and hired a fantastic CEO, in my view, recently. The company is focused on intravenous infusion, medication dispensing, respiratory care and infection prevention. Stryker (SYK) competes with ZMH and also sells equipment to hospitals. The company is well-managed in my view. I have downgraded my near-term view of C.R. Bard (BCR) due to the strong performance after they issued debt to repurchase a significant amount of stock, driving the price to an all-time high and the valuation a bit above peers. Longer-term, I do like their diversification. Boston Scientific (BSX) might well be the most troubled company in the industry (in my opinion, at least). Its P/E is high because its earnings have fallen rather than because it is viewed as a strong growth company like the three that follow. Their CEO departed suddenly recently. I don’t mean to sound negative about the name, though, but I want to make sure that I convey that this is a “turnaround” story, at least a potentially positive one. BSX has divested some businesses and has focused more on cardiac/cardiovascular. Varian Medical (VAR) looks expensive to me, but that is usually the case for this great company that treats cancer with radiation. Investors like their steady growth and active share repurchase program. Intuitive Surgical (ISRG) remains one of my favorite stocks in this industry due to its monopoly status as the only provider of robotically-assisted surgery. I described ISRG in great detail last December, using it as an example of what I called a “Good Company for 2011”. Despite the stock's 41% rise this year and a move to an all-time high close earlier this month, the stock looks attractive to me. The most expensive stock on the list is Edwards LifeSciences (EW), but this company could have a key advantage in its new transcatheter valve, which has been approved in Europe and is likely to be approved in the U.S. within the next year. This new technology dramatically increases the number of patients who will be able to have their heart repaired. While the company has a first-mover advantage, there will almost certainly be others following, including STJ. So, hopefully my brief comments on these large-cap medical device companies gives you a starting point for investigating this group further. I continue to believe that the industry is one of the more interesting components of healthcare. Investors who were disappointed by the slowdown as the economy contracted may return to this group as fundamentals improve over the next few years.

Mark Wolfinger helps a spread trader think through a mid-trade decision

Mark Wolfinger reviews the choices a spread trader faces upon expiration / assignment Warning: today's post isn't the shortest, but I wanted to give this trader a comprehensive response to the questions posed (which are themselves not too simple). If you're new to options and particularly to spreads, I'd urge you to follow along. This Q&A illuminates some critical gaps you'll want to make sure are filled before you trade with real money.

Mark Wolfinger addresses the question on every options trader's mind: how to prepare for debt-ceiling endgame?  Everyone knows that the United States cannot default on its obligations. The results would be catastrophic for the whole planet.

Dan Passarelli gets basic - elemental, even - and explores the 3 major drivers of options value  Ancient Babylonian philosophers considered all things to be constituted of one or more of the four classical elements: earth, air, water, and fire. In this world view, the natural environment consisted of objects composed of varying portions of each of these fundamental elements or forces. While modern atomic theory has supplanted this concept, these historic constructs can help us understand the importance of primal forces impacting various option trades.

Dan Passarelli continues his exploration of the 3 major drivers of options prices In part 1, I introduced the 3 primal forces of the options world: price of the underlying, time to options expiration, and implied volatility (IV). Like the classical four elements of nature - earth, water, air and fire - most if not all options action stems from the interaction of these 3 drivers.

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Alan Brochstein Looks at Some Companies With Potential to Do Well in a Weak Economy

Alan Brochstein checks out utility stocks for income-seekers It has been several months since I examined utility stocks for potential bargains. Most recently, I looked for high-yielding utilities with low debt and low pay-out ratios, highlighting 11 utilities yielding more than 4.5% in March. Most of them have performed well, including DPL (DPL), which I had called out as the most interesting of the eleven and subsequently entered into an agreement to be acquired. In light of the recent sharp decline in the market as well as the drop in interest rates and the yields on bonds, which compete for investor dollars, I wanted to take another look at the sector.Utilities seem to be a safer bet than stocks in general in a potentially weak economy. Today, I am tilting the focus towards not only high yield and increased safety but also the potential for dividend growth. Here are the screening parameters: • Yield > 4.0% • Net Debt to Capital < 65% • Payout Ratio < 75% • Dividend Increases:  At least 3 in the past 5 years • 5-year Dividend Growth Rate >5% • Market Cap > $1 billion The goal is to find higher-yielding companies without excessive leverage and reasonable payout ratios that have been increasing their dividends in recent years. Here are the 8 that made the cut: [click on the chart above to enlarge it] As always, remember that these are not recommendations.  Further, while the companies have been raising their dividends, there is no guarantee that they will continue to do so.  By focusing on payout ratio and the amount of debt, we are hopefully eliminating any companies that might be constrained from continuing to raise dividends. Looking at the list, the yields run from 4% to as high as 5.3%. Half the companies have raised their dividend in each of the past 5 years. I have also included a column for P/E (based on 2012 estimates) as well as a column that compares the current P/E to the average of the past 5 years. With the exception of Westar (WR), which also has the highest payout ratio and highest net debt to capital, all of the stocks are trading below their average P/E. I have kept Exelon (EXC) on the list because the payout ratio appears to low enough that the dividend is likely to be maintained, but I want to point out that earnings in 2012 are supposed to decline significantly (29% from 2011 according to analyst estimates) as hedges roll off. I would also note that PPL (PPL), which has recently transformed itself with a large acquisition in the UK, is expected to see earnings decline slightly in 2012. The other six names are expected to grow earnings in 2012, with Westar (WR) currently expected to grow 16% after declining slightly this year. When evaluating Utilities, there are many factors to consider beyond those that I have used to create this list, including the strength of the local economies in which they conduct business, the company's relationship with regulatory authorities, the amount of non-regulated business and the mix of fuel types. I continue to believe that investors should be considering alternatives to bonds. Along with Real Estate Investment Trusts and high-quality dividend-paying companies, utility stocks offer reasonably high yield with the potential for growth. While the growth potential might be less than the other areas I mentioned, utilities should fare better if the economy weakens further or goes into recession again. They should also perform better than long-term bonds should the economy strengthen and interest rates rise. The screen I shared is designed to identify higher yielding utilities with signs of sustainable dividends. I encourage you to explore this sector and look forward to hearing your observations.

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The recent market downturn has been broad-based, with aggressive selling pretty much across the board. When the majority of stocks are falling uniformly, some stocks end up getting penalized perhaps too harshly. While the pundits are debating the increasing likelihood of slower growth or even another recession, it seems that stocks generally are priced very pessimistically already, with the overall valuations, as measured by P/E ratios, similar to where they were at the lows in early 2009.

Mark Wolfinger untangles how professional traders vs. individual investors hedge their risks As I catch up on All-Stars posts, I see I missed a few juicy observations by TradeKing forum regulars. Case in point: back on 8/18, when the markets were still roiling after the debt ceiling crisis, stoicathos asked the forums: What effect, if any, will options expiration this weekend have on the market? Can we expect some positive pressure tomorrow as options traders close their short stock positions that were covering the puts (now in the money) they sold?Hello Stoic,

Mark Wolfinger helps a trader weigh the question of how to react as options expiration day nears I'm catching up after a summer hiatus from my All-Star blogging and found an interesting question from TK maven Spshapiro. It's too late to inform his choice in advance for this particular trade - and I hope everything turned out well with that one! - but it did get me thinking. I thought maybe others might find the following scenario useful to consider. Spshapiro writes:  

Alan Brochstein screens for "deep value" stocks

Rob Smith does not currently hold any positions in the securities mentioned in this post.At the time of publication and in the preceding month, TradeKing and the third-party content provider did not have ownership greater than 1% in any stocks mentioned here and do not have any other actual, material conflict of interest known at the time of publication.

Rob Smith does not currently hold any positions in the securities mentioned in this post.At the time of publication and in the preceding month, TradeKing and the third-party content provider did not have ownership greater than 1% in any stocks mentioned here and do not have any other actual, material conflict of interest known at the time of publication.

Recap for Tuesday, December 18th by Kevin CorriganDid you miss Tuesday’s TradeKing Midday Market Call?

ALAN BROCHSTEIN LOOKS FOR SMALL-CAPSWith just a few weeks to go, it is looking possible smaller stocks could again underperform bigger ones in 2012, though not by as wide a margin as last year.

Alan Brochstein Shares Four Ideas  I must like robots!