Option Tip – Monday, December 05, 2011
Navistar (NAV) Buy-Write Trade

This Option Tip Provides Profit from Elevated Volatility with This Buy-Write Trade!

Navistar Options Supplies Great Premiums to be Collected!

Navistar (NAV) Shares Upgraded to a "Neutral" Rating by Goldman Sachs (GS) Analysts and Passes Key Test!


NAV-international lone star

It can be easy to get wrapped up in the day-to-day, minute-to-minute drama unfolding in Europe. But it is important to keep an eye on the situation at home, which, thankfully, is a lot more uplifting.

Corporate profits are at an all-time nominal high, and consumer confidence is surging. This optimism is manifesting itself in demand for durable goods, which were too expensive to buy during the recession.

A great stock poised to profit from this is Navistar International Corp. (NYSE: NAV) which is the basis for this option tip. This company manufactures and markets medium and heavy trucks, school buses, mid-range diesel engines and service parts. And Wednesday, last week, a Goldman Sachs analyst upgraded the stock to “Neutral” from “Sell.”

NAV logo

Navistar International Corporation (NYSE: NAV) (formerly International Harvester Company) is a United States-based holding company that owns the manufacturer of International brand commercial trucks, MaxxForce brand diesel engines, IC Bus school and commercial buses, Workhorse brand chassis for motor homes and step vans, and is a private label designer and manufacturer of diesel engines for the pickup truck, van and SUV markets. The company is also a provider of truck and diesel engine parts and service.

The current record shows headquarter located in Warrenville, IL with employee size 250 - 499 and has annual revenue of $9.713 billion. The company's products, parts, and services are sold through a network of nearly 1,000 dealer outlets in the United States, Canada, Brazil, and Mexico and more than 60 dealers in 90 countries throughout the world. The company also provides financing for its customers and distributors principally through its wholly owned subsidiary, Navistar Financial Corporation.

Statistics Supporting the Option Tip

Navistar International surged 4.85% on Friday, to close at $40.23.Its overall traded volume was 2.09M shares during the last session and the stock had an average daily volume of 1.12M shares. NAV shares were trading within the range of $38.82-$40.50 while its opening price was $38.82.

The stock has a 52 week low of $30.01 and 52 week high of $71.49. NAV’s market capitalization is $2.92B and it has 72.57M outstanding shares.

Potential upside of 47.5% exists for Navistar International, based on a current level of $40.20 and analysts' average consensus price target of $59.31. The stock should find resistance at its 200-day moving average (MA) of $51.98, as well as support at its 50-day MA of $38.14.

120511-NAV chart

A Crystal Ball Reading to Help the Option Tip

By using accounts receivable and days sales outstanding you can judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of days' worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Is Navistar International sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:


Source: S&P Capital IQ. Data is current as of last fully-reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable.

Watching the trends

When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars indicates a trend worth worrying about.

Differences in business models can generate variations in DSO, so don't consider this the final word -- just a way to add some context to the numbers.

Therefore, will Navistar International miss its numbers in the next quarter or two?

I don't think so! AR and DSO look healthy. For the last fully reported fiscal quarter, Navistar International's year-over-year revenue grew 9.8%, and its AR grew 7.6%. That looks OK. End-of-quarter DSO decreased 2.0% from the prior-year quarter. It was down 1.3% versus the prior quarter. This certainly helps bring some concrete evidence to this option tip!

Analysts Upgrade

Navistar was upgraded by equities research analysts at Goldman Sachs (GS) from a "sell" rating to a "neutral" rating, with a $38 price target, in a research note issued to investors on Wednesday, which certainly boosts this option tip.

Navistar derives a significant amount of its business from sales of military vehicles such as mine-resistant, ambush-protected vehicles, or MRAPs. But military spending cuts are significantly reducing sales of those vehicles.

However, the company's commercial truck business has gotten a boost from increased demand from the recovering trucking industry. And while its engine business continues to post losses, its margins appear to be similar those of other similar companies.

The Option Tip

This option tip helps you gain exposure to Navistar by using a buy-write trade. This involves buying the stock for $4 and selling the NAV Jan 45 Call against it. The Jan 45 Calls are trading at a 47.5% implied volatility, which means that there are great premiums to be had by selling them.

Should Navistar close above $45 at January expiration, the trade will return 15.38%. If Navistar does not, the premium received from selling the call is yours to keep and effectively lowers your basis in the stock by $1.00.

The bottom line is that this trade increases the odds of achieving above-market returns while simultaneously reducing downside risk. That is a win-win situation from this option tip! Here are the details of this trade idea:

Stock/Index: NAV

Stock Price: $40

Option Play: Covered Call

Buy Stock: 100 Shares @ $40

Sell Call: NAV Jan 45 Call @ $1.00

Net Cost: $39.00 = $40 – $1.00 (Net Cost = Stock – Premium Received)

Breakeven: $39.00 = $40 – $1.00 (Breakeven = Stock Price– Premium Received)

Max Profit: $6.00 = $45 + $1.00 – 40.00 (Max Profit = Strike Sold + Call Premium – Stock)

Max Loss: $39.00 = $40 – $1.00 (Max Loss = Stock – Call Premium)

Call Away % Return: 15.38% = $6.00/$39.00 (Call Away Return Max Profit / Net Cost)

A Further Option Tip

For a hedged play on Navistar, look at the Jan '12 $35.00 covered call for a net debit in the $33.57 area. That is also the break-even stock price for this trade. This covered call has a duration of 50 days, provides 12.51% downside protection and an assigned return rate of 4.26% for an annualized return rate of 31.10% (for comparison purposes only).



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