Railroads Are Still A Good Investment. Here’s Why And Where To Put Your Money

| October 27, 2017 | 0 Comments

optionsLet me tell you about an exciting new transportation technology. It’s ground-breaking. It’s game-changing. The entire face of shipping could be altered. It’s… er… railroads. Okay, so maybe not so exciting. Or new.

In fact, since the first major railroads were built around 200 years ago in the US, not much has changed. Trains are now powered by diesel or electric locomotives instead of steam – but the basic operation is essentially the same. More importantly, railroads are probably still the most cost effective way to transport raw materials and heavy goods on land.

Of course raw materials are then turned into construction materials or sources of fuel (which then also may be transported by rail). It’s these materials which help the economy function and expand. Without railways, the cost for these materials could be much higher – which would be passed on to the buyers.

As such, railroads tend to do well when the economy is doing well. They also can be a decent gauge of future economic activity. If an investor believes the economy is going to improve, one way to capitalize from the scenario can be investing in railroad companies.

Union PacificIn the US, the largest railroad company is Union Pacific (NYSE: UNP) with a market cap of $90 billion. UNP was founded all the way back in 1862. With its long history, it’s probably not a surprise the company’s rail network consists of over 32,000 miles.

If you want to invest in a growing US economy, investing in UNP is a reasonable way to do so. Moreover, at least one trader is placing a massive options bet on the company thriving over the coming year.

The trade I’m referring to is a January 2019 call spread, which traded a whopping 60,000 times. The trader purchased the 130 strike and sold the 160 strike for a total cost of $3.56. That means the trade breaks even at $133.56 by January 2019 expiration.

With the stock around $111 at the time of the trade, this is very clearly a bullish bet on UNP. In fact, the trader spent $21 million on the massive spread. Of course, max gain on the spread is also $158 million, so there’s definitely some serious upside to be had.

Personally, I like using UNP as a proxy for the economy. And, there are plenty of reasons to believe the economy is going to continue to grow. However, I’d recommend a more affordable trade.

The June 2018 125-145 call spread is a bit cheaper at $2.50 and is closer to the current stock price. You are sacrificing 6 months of time, but there’s still plenty of upside available. Breakeven occurs at $127.50, so only about $15 higher than where we are now. Plus, you can still earn $17.50 at max gain.

Buying very long-term options is nice if you can afford it, but you definitely pay up for the time. By choosing an expiration six months earlier, we can do a similar trade for $1 cheaper and 5 strikes closer to the stock price.

 

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Category: The Spread Trader

About the Author ()

Jay Soloff is an options analyst with Investors Alley.