Call Options Or Put Options On Humana (HUM)?

| September 26, 2012 | 0 Comments

Health Care Select Sector SPDR OptionsHumana (HUM) is one of the major health insurance companies in the US.  At the end of 2011, they had 11.2 million members enrolled in medical benefit plans.

HUM currently trades for $70.00 per share.  The shares are up 26% from the 52-week low of $59.92, but the shares are still down 27% from their 52-week high of $95.86.

Is this an opportunity to buy call options on HUM as health insurance enrollment expands?  Or should you buy put options on HUM as premium rate increases decelerate?

The bulls make a convincing argument…

Health insurance companies have been at the epicenter of the hotly contested health care reforms taking place in the US.  And they’ve come out of the storm as clear cut winners.

You see, the new rules are already having a dramatic impact on enrollment. 

Every year from 2000 to 2010, the percentage of Americans covered by health insurance shrank.  This was primarily due to a decline in employer sponsored health care plans.

But last year this trend reversed.  In 2011, the percentage of people with health insurance ticked up from 83.7% to 84.3%. 

Here’s the thing…  There were still fewer employer sponsored health care plans.  But the percentage of people with health insurance increased.   This is most likely due to parents’ ability to keep adult children on their plan up to age 26.

Put simply, this is a huge boost to insurers like Humana. 

They’re adding healthy young individuals and losing older workers who are more likely to have health issues.  This is a big boost to profitability.  And it should drive strong earnings growth over the next few quarters. 

But the bears have a compelling case as well… 

Health care enrollment trends aside, insurers face a tough road ahead.

The most pressing issue is the new requirement that insurers spend 85% of premiums for large group accounts and 80% of the premiums from individual and small group accounts on medical costs.  The excess premiums must be refunded to the payers.

In other words, Humana’s gross margins are capped.  And they can’t generate growth by simply raising premiums. They must either lower operating expenses, so more of the gross profit makes it to the bottom line, or they have to add new members. 

Unfortunately, Humana won’t be able to cut costs at the same time as they’re implementing the changes the new health care reforms have mandated.  And enrollment isn’t expected to dramatically expand until January 2014.  That’s when the individual mandate requires all US residents to obtain minimum essential coverage.

In other words, it’s going to be hard for HUM to grow profits over the next year.  And slowing growth is a sure fire way to send a stock lower.

If you think the bulls are right, take a look at buying the HUM January 2013 $80 Call for around $1.25. 

If you think the bears are right, take a look at buying the HUM January 2013 $60 Put for around $1.35.

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Good Investing,

Corey Williams

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Category: Call Or Put Options?

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.