When GE gets into a funk, so do legions of investors.
As one of America’s most-widely held stocks, General Electric’s (ticker: GE) recent drop below $30 to near a 52-week low is causing pain. (Investors who have held the stock since its 2000 peak are in profound pain, as shares have tumbled more than 50% since then.)
One way to deal with the latest weakness – and it does seem the stock will be stuck near $28 for a while – is to sell upside calls against shares. The strategy is called overwriting, an odd name that merely means someone owns a stock and sells calls against the position. This classic trading strategy is widely used to generate returns on moribund stocks.
Here’s how it works.
With GE at $28, investors would sell the September $30 call for 26 cents.
If the stock is below the call strike price at expiration, investors can keep the money received for selling the call. The company pays an annual dividend of 96 cents (the stock yields 3.4%) so within that context the call premium is a meaningful number. If the trade is done four times a year, investors can collect a conditional dividend of $1.04. What is the condition of the dividend-like payment? A willingness to sell the stock at the strike price, and give up any potential gains.
The trade has some key drawbacks. The amount of money received for selling the call is not huge. Some would say that the premium does not do enough to offset the risk that anyone who sells a call is obligated to sell the stock at the call’s strike price. If the stock trades at $30 or higher when the options expire, the stock will be exercised and sold. To prevent the exercise, investors can buy back the short call to close out the position.
Though the stock has ranged over the past 52 weeks from $27.10 to $33, and charts suggest shares could drop into a lower trading range, the stock has upside potential.
The trade has some event risk. GE is scheduled to report second-quarter earnings on July 21. A good report – even though it may seem unlikely today – could move the stock through the call strike price. The company also will participate in a series of bank conferences that provide ample opportunity for executives to say something that moves the stock.
GE also has attracted an activist investor. Trian Fund Management is pressuring GE’s management to improve performance. Subsequently, GE has cut $2 billion of expenses. Still, the stock has dropped despite Trian’s interest, suggesting that the risk of selling calls is somewhat tempered as it is hard to imagine an activist investor, even one well respected like Trian, can do much to unlock value in a $242 billion international conglomerate that is confronting profitability pressures. Moreover, the analyst community is turning on GE.
To be sure, it is hard to make a convincing bull thesis for why anyone would want to initiate a new position in GE – a point that points back to managing existing positions with options to increase returns. It is perhaps possible that the stock price would jump if the company were broken up into a bunch of smaller, listed stocks, but who knows if that is even realistic.
The facts are that the stock is behaving weakly, options trading patterns are mixed, and the sale of a well-placed call should help investors incrementally increase the returns of a stalled stock.
The GDP equation (C+I+G+X) has been engrained in students beginning with their first high school “econ” class. Any student today would (should) be able to tell you that Consumption makes up ~70% of the total in the U.S. calculus. To a point, however, that is slightly misleading to equity-minded investors, inasmuch as healthcare expenditure makes up ~17 pct. points of the total and is accounted for in the C term. (An amended equation could look more like: C+H+I+G+X.) The remaining consumer term or what we generally think of as Consumption, the “things we need” – Staples – and “things we want” – Discretionary – is more than twice as large a weight in GDP, 51.7% (or, 68.9%-17.2%), as the two sectors represent within the broader S&P (21.6%, or CD 12.3% + CS 9.3%). While the consumer, measured in economic terms, may be doing OK (retail sales up +0.39% in April and +1.8% over the past six months), index gains will be far more reliant on the Investment term, of which capex makes up 75%, or 12.5% of GDP. Here the data have also been improving (non-residential fixed investment up 3.1% Y/Y). Remember one company’s capex is another company’s revenue, and the two sectors which are the largest beneficiaries of capex, Industrials & Technology, make up ~33% of the Index weight.
Industrial Companies Have Under Invested During the Past Decade
Last Time Fixed Assets Were As Old As They Are Now Was in the 1960’s
Industrials Earnings Expected To Accelerate in the Back Half of the Year…
…Extending the Secular Improvement in Industrials Margins
As of 11:04am:
With Trump away and a lack of drama out of Washington DC, the markets continue drifting higher and the S&P and Nasdaq Composite opened at record highs. Most sectors are fractionally higher with consumer discretionary (+0.9%) in the lead, but energy (-0.1%) is down on lower crude oil. The dollar and treasuries are flat, gold is up 0.1%, while oil is down following OPEC’s extension announcement.
§ As expected OPEC extended their production cut agreement by nine months. There was hope in some camps that OPEC might do something more dramatic, but that is not the case and Crude prices are lower this morning. OPEC is set to hold a press conference today with their formal announcement.
§ FOMC meeting minutes out yesterday afternoon support expectations for a June rate hike. The minutes include a comment that a hike “would soon be appropriate.” The Fed also indicated that it plans to begin shrinking its balance sheet later this year. The market is assigning a 100% expectation for a hike on June 14th, up from 93% this time last week.
§ Weekly unemployment numbers released by the U.S. Department of Labor continue to show strong demand in the US. Reported Initial Jobless Claims were 234,000 vs polled expectations of 238,000, which is just 1,000 more than the previous week’s revised 253,000 claims. Reported Continuing Claims were also better than expected at 1.923 million claims vs estimates of 1.925 million.
§ On the corporate front Best Buy (+16%) beat on bottom line and guided higher; William-Sonoma (+3.9%) beat expectations, Dollar Tree (+2.3%), Net App (+2.9%) and Aerie Pharmaceuticals (+36%) on positive phase III trial data, and Sears Holdings (+25%) on top line beat.
§ Nasdaq welcomes Appian (APPN), who priced 6.25 million shares last night and opened for trading moments ago with a 25.1% gain.
It has been 12-weeks since the S&P 500 peaked at 2,401 back on March 1st. While there have been a few minor tests of this 3-month resistance level, the large cap index is today seeing its first convincing breakout with a 0.5% gain to a “last sale” of 2,415. Despite historically high multiples, weakening economic data, flailing presidential policies, negative geopolitical events including independent investigators and threats of impeachment, the Fed raising rates and suggesting balance sheet reduction, etc. etc. etc., “the most hated bull market in history” continues on. The size of the consolidation pattern the SPX is now emerging from has an upside measured move towards 2,479. Note a number of Elliot wave theorists are counting this uptrend as a “wave five” of a 5-wave impulse (i.e. uptrend) which began in the fall of 2016. Expected to then follow is an ABC 3-wave decline.
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