Friday, December 29, 2006

Boring Old USG Sheetrock Play

I know, I know. You're probably thinking what kind of option trader even considers an old Berkshire Hathaway Buffett holding like USG? Well here are my reasons and as always in the Jungle, you're welcome to dispute these and/or wave them all off (that's the fun about optionocracy).

Ok here's my take:

1. Fundamentals (Fundies)-take a look at Seeking Alpha's A Closer Look at USG Corporation review of USG's recent action. I wanted to make sure that the whole Asbesto thing is behind USG, which it seems to be.

I know that Buffett's cost basis is around the $40s but he still could add to his position later. USG seems to have a buffer for a weak housing market with commercial construction continuing strong and of course, like Buffett, I think the brand "sheetrock" is strong like "coke".

2. Technicals-for longer term option plays I like solid companies (ie Microsoft in July 06) that get beat up once in a while. The chart below validates that USG seems to have found strong support in the mid-40 range.

The chart also shows some accumulation going on once it broke above the 50 level. A breakout above 58.50 with strong volume would definitely confirm a new uptrend beginning. Also, for you technicians out there, we are seeing the beginning of the famous "rounded bottom" recently. That tends to be bullish.

3. Option pricing-I'm looking at the Aug07 50 Calls that are currently priced at $9.80. Why the 50's? Because we have some plenty of intrinsic value and that is where I'd like the stock not to drop below.

A premium caveat is needed here however. The theoretical value for the Aug07 50 Calls is currently around $9.00. I'd like to see the premiums there if possible for entry.

The delta is currently 0.75 which gives you a nice .75 increase to your cost basis for every $1.00 increase in the underlying USG security (all things being equal).

4. Implied Volatility-the IV for the Aug07 50 Calls is currently around 35%. That is moderately above the 52 wk IV lows of 31%. That means that if we get an IV hike (usually around earnings or any anticipated event where there is an uncertain outcome) we'll get extra "juice" poured into the premiums (this could be a chance to insert an Option Jungle pun from now on-let's call any increase in IV "jungle juice").

5. Risks-the housing sector gets worse and the demand for sheetrock could decrease. Buffett decreases his holding in USG. Some sort of Asbesto claim rearises. The stock drops below $50 for a shorter term concern and then $46 for a longer term technical concern. The volume and open interest for these options is light but the spread between the bid and the ask is still reasonable.

6. Entry-I'd like to review the prices after the new year and look for an entry where the premiums start getting closer to fair theoretical value.

Grab a "vine" and swing by to post your comments as always welcomed.

Happy New Year and I'm still debating on my other healthcare stock that I wanted to discuss.

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