Jill: Last week, Skip and I traded a synthetic strategy on Disney (DIS). This week we are going to employ a similar play on shares of Johnson & Johnson (JNJ) (or if you want a throwback to the good ol' trading desk days...Johnny John). Before I get into the fundamental case, I encourage all of you, especially our newer traders, to go back and review the full write up Skip did on The Synthetic Approach to Buying an Option. You must understand this basic principle of options trading. On Skip's list of most important levels of knowledge for the options trader, this is number one.
From a fundamental perspective, JNJ appears to be a bit rich in terms of valuation. I preferred the stock more over the summer, on the back of the re-engineered financing of the Synthes merger, and that thesis played off nicely, returning almost 11%. So why do we still think there is value in JNJ as a longer-term play?
JNJ is rated as the globe's largest and most diversified healthcare company. The company stands alone as a leader over the key healthcare industries. 40% of JNJ's income is from its medical devices and diagnostic division, while 23% comes from consumer brands such as Band-Aid, Tylenol, Immodium, Neutrogena and enormous line of baby products. JNJ keeps a diverse revenue base, a solid research pipeline, and remarkable cash-flow generation that together build a wide economic moat. Furthermore, the company has been continually raising its dividends for 46 consecutive years. It has hiked the dividend by an astounding 13.1% annually over the years. Not that bad for a boring Big Blue name! Even though investors have been reluctant to put cash to work due to uncertainty surrounding fiscal policy, I think this is an excellent opportunity to do some old fashioned stock picking, and companies sporting healthy balance sheets, have global exposure, are focused on growth and diversification and consistently reward investors will be the relative outperformers.
Skip: JNJ is quietly moving into breakout mode. That would occur if it could move into the mid-70s as JNJ's all-time is just under $73, a level it hit just four weeks ago.
JNJ will trade ex-dividend on November 23. The amount of that dividend is $0.61 per share which equates to approximately an annual dividend percentage return of 3.5%. Holding the stock for three months to get that dividend is not the same as what is known as scalping that dividend. Scalping a dividend implies a hit and run type of trade, where the trader moves into the stock to capture the dividend and then exits it with little to no capital lost in the process.
Scalping a dividend should be done using married puts as I think that is always the prudent tactic to use when trading stock from the long side. JNJ tends to trade at a low options volatility level (currently around 13) which is a bonus for any dividend scalping trade.
This trade is one of medium risk because that risk is 100% controlled, while high in potential reward because it is a bullishly-biased trade; the tactic used being the synthetic call set up.
Trades: Buy 300 JNJ shares for $69.70 and buy to open 3 January 70 puts for $1.80.
The total risk for this trade is less than $1.00 to expiration in January. As always, I will monitor the trade on this site in the comments section below.
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