Stock Options To The Rescue! Joy Global (JOY)
Today we’re looking at an option trade on Joy Global to reduce your cost basis and profit from the recent decline in the stock.
Here’s what happened…
Joy Global (JOY) shares are down 7% from $59 to $55 today. They beat Wall Street revenue and earnings estimates, but slashed their full year earnings estimates.
Here’s the deal…
The mining equipment manufacturer and servicer reported a strong quarter. Quarterly profits rose to $2 per share from $1.52 a year earlier. And they beat analyst estimates of $1.95 per share.
Revenue also grew 45% last quarter to more than $1.5 billion. Amazingly, it was the fifth consecutive quarter JOY has had double digit year-over-year revenue growth.
However, management said a slowdown in mining activity will hurt full year earnings.
Here’s the kicker…
The mining industry continues to be hit hard with fears of global economic slowdown.
Slowing economic growth hurts demand for raw materials needed to fuel growth. Now JOY is feeling some pain as mining companies dial back their spending on equipment used to extract coal, copper, gold, and other minerals.
Joy’s CEO Mike Sutherlin said new orders are slowing because of weakening fundamentals and project timing.
In order to stay ahead of a potential slowdown, JOY is turning their focus to cost cutting.
Obviously, an industry-wide slowdown in mining activity is bad news for JOY. But their management team is running ahead of any problems. They’re making plans to prevent a major shortfall in the future.
Anyone who bought JOY ahead of today’s earnings is feeling blue. But with management’s plan to cut costs, they could survive a slowdown without a major impact to profitability. Let’s look at how selling a covered call can rescue your JOY trade.
Here’s what to do now…
Let’s assume you invested $5,900 to buy 100 shares of JOY at $59.00 before earnings. So you’re down about $400 on the trade. But there’s not much downside in stock.
Remember, a major slowdown in mining activity is already priced into JOY. The stock has fallen 45% from the 52-week high. And there’s a strong technical level of support around $50.
Selling the JOY October 2012 $60 covered call can rescue this trade.
Right now the option premiums on JOY are sky high. You can sell the October 2012 $60 call for $5.30. So you collect $530 in option premium as the seller. And you still own 100 shares of the stock.
Selling the call option immediately recoups all of your $400 loss on the stock and then some.
There are two possible outcomes for this trade…
First, if JOY is above the $60 strike price, the option holder will exercise their right to buy your stock at $60 per share. So your 100 shares will be called away or sold for $6,000.
But that’s just fine… you bought the stock for $5,900. So you’re realizing a small $100 gain on the sale of the stock. Plus, you get to keep the entire $530 in option premium. So your total profits are $630 or a little over 10%.
A more likely scenario is JOY never reaches $60.
Don’t forget, an industry-wide slowdown will likely keep JOY’s stock price from bouncing back in the short term.
If JOY stays below $60 until October, the option will expire worthless. You’ll get to keep the $530 in option premium. In essence, the option premium lowers your cost basis from $59 to $53.70 per share. And at a current price of $55, you’re already making money.
And the best part is you still own the stock. If the fundamentals have improved, you can hold the stock and reap any profits from the lower cost basis. Or you can sell another call option against your shares and lower your cost basis even more.
In my opinion, selling a covered call against your JOY stock holdings is much better than selling or doing nothing. This strategy reduces your costs basis and puts you on the fast track to turning this losing trade into a winner.
Good Investing,
Corey Williams
Category: Stock Options To The Rescue!
