63% Return Possible With This ‘Paper’ Trade

So often, we see investors and speculators put the cart before the horse in the market. They think only about the short term and rarely look at the larger picture. Today, however, we have an opportunity where the opposite is happening.

International Paper (NYSE:IP) is a company most agree is similar to buying a candle company at the advent of electricity. With print dying across most industries – you’re reading this article in digital form for instance – the largest paper company in the world does sound like a bad bet.

But International Paper does more than just make writing paper. It is also the leader in containerboard and corrugated packaging. With the rise of Amazon and other online retailers, the shipping industry is still strong. International Paper has made that adjustment too.

Long term, however, it still doesn’t have a breakout coming its way. The company is large, but that’s because it has had to spend to keep its market position. Unfortunately, it has had to spend money it doesn’t necessarily have.

Right now, IP has $10.7 billion in long-term debt. That gives the company a debt-to-equity ratio of about 1.6… far too high for any investor’s liking in today’s climate.

That’s not to say the company is in trouble. It has a few years before the first of these bonds are due, the earliest being in 2021. And it has been able to spread these obligations out over a 27-year period. So, there’s no giant looming deadline for it to refinance all of its debt.

And it can still more than cover its current portion of obligations with its free cash flow. In fact, the company still has enough left over in the short term to continue paying its extraordinary 4.5% dividend.

Of course, even with its quite profitable packaging business, long term still looks mediocre at best. So, it should come as no surprise that the company’s stock carries mostly “hold” and “neutral” ratings from analysts.

That also explains why IP’s stock is trading where it was five years ago:


Investors should actually be somewhat praised here for being skeptical about IP’s long-term health. It’s not as if the company is going anywhere… it just isn’t going to impress anyone on the upside.

That being said, those same investors are missing a short-term opportunity… one a studious options trader can take advantage of…

IP’s Big Potential By Flying Under the Radar

Retail sales for the holiday shopping season seem to be mixed. Traditional retailers like Macy’s, J.C. Penney, Kohl’s and Nordstrom all have announced weak-to-terrible holiday sales. That runs counter, however, to what those retailers with large online businesses are saying.

Both Target and Amazon have reported tremendous holiday sales figures already — each, primarily, because of online sales.

While this kind of mixed bag of retail performance can cloud the top-down view of holiday economic activity, the picture is crystal clear for those online retailers and others involved in the shipping of their products… namely International Paper.

IP isn’t a very PR heavy company. Its management attends conferences from time to time. But with products like corrugated packaging, it just doesn’t grab headlines. So, as of now, it seems it might just be flying under the radar.

If online retail and shipping had a record quarter, then IP’s products must have had at least near record demand. With its low profile, there’s only one real way to know. On January 31, the company will announce its fourth quarter and 2018 full-year financial results. Look for them to surprise many investors.

The company flies under the radar so much that it is able to consistently confound and surprise analysts. In each of the last several quarters, IP beat analysts’ earnings estimates and not by a little bit. We’re talking 6.7%, 5.6%, 9.2% and 5.4% higher EPS performance than analysts predicted in the last four quarters.

With the trend surrounding this particular holiday season quarter, it could absolutely smash estimates… finally gaining enough investor attention to send shares higher… at least in the short term. And that’s just enough to give traders a great opportunity.

Let’s look at the strategy they’d use to take advantage of this kind of chance.

A Strategy For Short Term Bulls

As noted, IP doesn’t necessarily have an amazing long-term outlook. It’s not exactly set for a decline. But its debt load and relatively sideways business, not to mention new competition, don’t allow for much upside.

However, this perfect situation in the short term — low profile, high chance of surprise — is tradeable.

Using a strategy we’ve discussed before, bull call spreads, traders are able to lock in short-term profits without owning shares for the long term. With IP, that’s the ideal way to play it.

The way a bull call spread works is by buying a call option on the underlying shares, in this case IP. Then, selling a second call option with a higher strike prices but the same expiration date on those same shares.

This results in a net debit to the trader’s account. But that entry cost is the total and maximum risk he is exposed to. The upside is found by taking the difference in strike prices and subtracting that cost.

You can visualize how this kind of trade looks here:


Source: The Options Industry Council

Let’s look at a specific example for IP…

A Specific Trade For Short Term IP Bulls

A trader could enter a bull call spread trade on International Paper by buying a February 15 $45 call for $1.45 per share and selling a February 15 $47.50 call for $0.50 per share. That’s a cost of $0.95 per share. Since each contract is good for 100 shares, that’s a total net debit to the trader’s account of $95 plus commissions.

That’s all he’d have to lose. No matter what happens on Jan. 31, when IP announces its financial results, the trader doesn’t have any more than that at risk.

To find his upside potential, take the difference between the strike prices ($47.50 – $45 = $2.50) and subtract the entry cost ($2.50 – $0.95 = $1.55). Again, since each contract represents 100 shares, that’s a maximum gain potential of $155.

That’s not such a bad payoff for the amount at risk. Make $155 if International Paper does indeed impress investors on Jan. 31 for an investment of only $95. That works out to a 63% gain on the amount to enter the trade.

To reach that max gain, shares of IP would have to rise above $47.50 by February 15. That means investors would have to move its current price by 6.2%. Considering this historic shopping season for online retailers and the potential for surprise at IP, that’s certainly doable. In fact, if the company profits as much as we expect from this recent shopping boom, it nears “probable” territory.

— The Option Specialist

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About the Author: The Option Specialist