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State Street Corp. – A follow-up recommendation.

August 11, 2009 | About:
State Street [NYSE:STT] August 11, 2009: $51.10 10:30 AM EST

52-week-range: $14.43 (Jan. 20, 2009) - $74.04 (Aug. 11, 2008)

Dividend = $0.01 quarterly = 0.08% current yield


State Street* is one of the largest trust banks worldwide, combining banking, asset servicing, and asset-management operations. The company also offers services such as foreign exchange, cash management, credit, and electronic trading to help customers negotiate complex global financial markets efficiently. State Street Global Advisors, its asset management arm, is the world's largest institutional money manager and a leading provider of ETFs.

*company profile from Morningstar

I first wrote about State Street on April 28th when it was selling for $34.90 just ahead of the ‘stress test’ results. My suggested trade at that time was to buy shares and sell the long-term $40 call/put combination. That has worked out very nicely so far with the shares now above $51.

As a bank that gets about 70% of its profits from custodial services State Street is much more predictable in its earnings than the typical merchant bank. Value Line assigns STT a 95th percentile ranking (100th is best) for ‘earnings predictability’ and a ‘B++’ for ‘financial strength’.

Now that the acute fear has receded from healthier banks like STT, I think it is appropriate to take a further position with somewhat more aggressive strike prices.

State Street shares have pulled back over the past few days on news that they may need to add to legal cost provisions regarding their sub-prime portfolio holdings. The stock has come down about 9% since the announcement giving us a good entry point for this new commitment.

Even after this latest news Zacks is looking for 2009 – 2010 earnings of $4.03 and $4.35 making the multiple about 12.7x this year’s and 11.8x next year’s expectations. This is extremely low compared with all past P/E levels as can be seen in the chart below.

Here are the historical per share numbers from continuing operations as reported by Value Line:

Year .........EPS ..........Div. ...........B/V ......Avg. P/E .....52-Wk. Range

2002 ........2.20 ........ 0.48 ........ 14.73 ...... 20.9x .......32.10-58.40

2003 ........2.33 .........0.56 ........ 17.18 ...... 18.2x .......30.40-53.60

2004 ........2.47 .........0.64 .........18.46 ...... 19.5x .......39.90-56.90

2005 ........2.82 .........0.72 .........19.08 .......17.4x .......40.60-59.80

2006 ........3.26 .........0.80 .........21.81 .......19.0x .......54.40-68.60

2007 ........3.45 .........0.88 .........29.25 .......20.2x .......59.10-82.50

2008 ........4.30 .........0.95 .........25.24 .......15.0x .......28.10-86.60

Here’s my current play with STT:

................................................... Cash Outlay ........... Cash Inflow

Buy 1000 STT @$51.10 .................... $51,110

Sell 10 Jan. 2011 $50 Calls @$11.80 .............................. $11,800

Sell 10 Jan. 2011 $50 Puts @$10.30 .............................. $10,300

Net Cash Out-of-Pocket .................... $29,010

If State Street shares remain above $50 on expiration date in Jan. 2011:

• The $50 calls will be exercised.

• Your shares will be sold for $50,000.

• The $50 puts will expire worthless.

• You will have no further option obligations.

• You will hold no shares and $50,000 cash.

That’s a best-case scenario net profit of $20,990 / $29.010 = 72.3%

achieved on shares that did not need to move up at all from trade inception.


What’s the risk?

If State Street shares are below $50 on expiration date in Jan. 2011:

 The $50 calls will expire worthless.

 The $50 puts will be exercised.

 You will be forced to buy an additional 1000 shares of STT.

 You will need to lay out another $50,000 in cash.

 You will have no further option obligations.

 You will end up with 2000 shares of STT.


What’s the break-even point on the whole trade?

On the first 1000 shares it’s their $51.10 purchase price less

the $11.80 /share call premium = $39.30 /share.

On the ‘put’ shares it’s the $50 strike price less

the $10.30 /share put premium = $39.70 /share.

Your average net cost would be $39.50 /share.

State Street shares could drop by up to $11.60 /share (-22.7%) without causing a loss on this trade.

Summary: This trade allows for a total return of more than 72% in less than 18 months on shares that need only stay above $50 (where they are today). The option sales provide a margin of safety of more than 22% from the trade's inception price.

Disclosure: Author is long STT shares and short STT options.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 4.2/5 (5 votes)

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