How to Hedge a Romney Win – And Get Paid!
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I don’t know about you, but my crystal ball is busted. With it went my ability to predictively navigate the uncertainties that lie ahead. One of the chief uncertainties is knowing who’ll win come November. Each candidate’s agenda has both winners and losers so while we can’t with certainty invest to win we can at least hedge to thrive in either outcome.
Republican candidate Mitt Romney has made it known that he would “act to repeal Obamacare” if he’s elected. Some of you just got excited at just the thought it might happen, others of you are about to skip to the comment’s section and let me have it. Before anyone gets too hyped up about the politics involved, let’s remember this is actually supposed to be an article about investing. Let’s try and stay on task here.
There was an excellent article published right after the Supreme Court ruled on the individual mandate by The Motley Fool’s Morgan Housel entitled “Obamacare Lives: What You Need to Know.” In it Morgan wrote that, “Health insurers might be seen as losers -- shares of UnitedHealth (NYSE: UNH), WellPoint (NYSE: WLP), and Cigna (NYSE: CI) were all down big this morning -- but it's still entirely unclear how the bill will affect their business over the long haul. On one hand, there are a raft of new rules to comply with. On the other, they'll eventually see a flood of new customers effectively mandated to buy their product. First-day knee-jerk reactions rarely reflect the true impacts of big events.” I think we can safely assume that following the outcome of the election we’ll be faced with another set of knee-jerk reactions from traders who were wrongly positioned.
We’re not traders though; we’re investors who are in it for the long haul. We want to own great companies for the long haul and if we can get them for a great price all the better. Given the uncertainty surrounding the election we have the opportunity to pick up a great company at a better price. That’s because the health insurance industry that Morgan wrote about could be the most affected by knee-jerk reactions as opposed to long term fundamentals.
Let’s face it, the long term fundamentals of the industry are unfortunately compelling. We’re all getting older, heavier, and living longer (ok, that last one’s not bad at all). All of which are going to continue to put a strain on our health care system. This has given the insurance industry pricing power to raise rates every year to ensure that their bottom line keeps growing. I’ll take those fundamentals and that pricing power any day. If I can get it through owning the biggest and best operator even better, what I won’t do is pay any price for it.
With over 75 million members generating a hundred billion dollars in revenue UnitedHealth is compelling if for no other reason than their pure size and scale in the industry. At just 11 times earnings this $56 billion dollar company is downright intriguing. Not to mention above industry average margins and returns on invested capital. However, they are one election away from having their business model disrupted, that’s reason to pause. That’s why I want to be a buyer of UnitedHealth but not until after the election and at a price much cheaper than we can get today.
The industry it would seem is positioning for the President to be re-elected. Many analysts said that Aetna’s (NYSE: AET) deal to acquire Coventry (NYSE: CVH) was a signal toward an Obamacare consolidation phase as health care companies are preparing for a future governed by that law. That’s because they saw Aetna wanting to access to Coventry’s Medicare and Medicaid customers which are expected to grow under the law. That deal followed on the heels of WellPoint’s own purchase of a managed health care firm. What happens if the President loses his re-election bid and his landmark legislation is in danger of being repealed? Remember that bit about uncertainty earlier? I think it could cause health insurers to sell off if for no other reason than because it’s not the outcome investors are expecting. I want to hedge for that outcome and win no matter what happens.
I’ve already said I want to be a long term owner of UnitedHealth but not at today’s price given the uncertainty. To accomplish my goal to either buy UnitedHealth a lot cheaper or get paid while trying I’m going to set up a Put Ratio Spread which sounds fancy but isn’t all that difficult. Using December 2012 options I want to buy one $52.50 put and write two $50 puts.
As of the time of this writing I can set this up for a credit of $90 which is mine to keep no matter how things shake out. If post-election UnitedHealth soars as the uncertainty is erased I can console myself with the cash I received and go on my merry way. However, if UnitedHealth is dinged and falls anywhere below $50 I can sell my $52.50 put and buy back one $50 put and have another $250 left over while allowing the other $50 put to be assigned. That will leave me being a content long term owner of United Health for a lot cheaper that I can buy it today. If UnitedHealth just falls a little and is between the two strike prices I can sell the owned put and let the two written puts expire and be happy with my additional profit.
The trade accomplishes two things, it potentially lets me buy UnitedHealth for $50 a share and earn some income in the process. In fact, the position won’t show overall losses unless shares slide below $46.60. That's nearly a 15% drop from its recent price. This is exactly why I’m recommending this trade for my virtual “No Drip, No Mess” Portfolio, not because I’m really concerned about who wins the election but because I’d like to use the uncertainty driven volatility to potentially pick up a 5% allocation in a company I really want to own for the long term.
latimerburned has no positions in the stocks mentioned above. The Motley Fool owns shares of WellPoint. Motley Fool newsletter services recommend Coventry Health Care, UnitedHealth Group, and WellPoint. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.