Healthcare Strong: 4 Possible Covered Calls, Puts Trades to Exploit Bullish Momentum
Income traders who sell covered calls and cash secured puts favor stocks with bullish momentum.
By Donald E. L. Johnson
Cautious Speculator
XLV has great bullish momentum, but its options aren’t very liquid.
DHR has good momentum and its price fits more portfolios.
HUM and UNH are very high priced for many diversified portfolios.
The strategy is to look for puts strikes that offer good discounts and nice but not great returns on risk.
Health care stocks are favored by a lot of stock pickers. And Goldman Sachs found that hedge funds and mutual funds are over weight in three health care stocks.
They are Danaher (DHR), Humana (HUM) and UnitedHealth Group (UNH). Please click on the image an zoom in for a better view.
Buying 100 shares of HUM or UNH at $546.78 and $531.16 per share respectively times 100 shares per options contract makes sense only if you are putting $50,000 to $60,000 in each stock in a diversified portfolio of five to ten stocks. That eliminates HUM and UNH as possible trades for a lot of individual investors.
Price to free cash flow (P/FCF) is the most important valuation metric. HUM is a better value with a P/FCF of 8.3, which is just under half of UNH’s 16.3 P/FCF.
Another health care stock to consider is DHR, which is trading at about $27,423 per 100 shares. But it is fairly expensive with a 28.6 P/FCF.
The higher a P/FCF, the more bullish the market is on a stock. In this market and for this income trading strategy, I prefer P/FCF ratios under 20 but sometimes will trade stocks with P/FCF ratios in the high 20 and low 30s.
At the moment I’m short CAT puts. Its P/FCF is about 33 and it’s a stock I want to own at a price that’s 15% to 25% below where it now is ($236.13 vs its FVE of $192).
On the point and figure (P&F) charts at StockCharts.com, DHR’s price objective is $359 (vs. 12.2.22 close of $274.23), HUM’s objective is $737 ($546.78), and UNH’s objective is $594 ($536.13). XLV’s price objective is $181 ($139.78).
P&F charts reflect the flow of funds into and out of stocks. P&F price objectives are, effectively, the market’s consensus target prices versus the thoughts of individual stock analysts whose targets sometimes match the P&F charts’ price objectives. P&F charts’ price objectives change with the markets, while analysts usually are slow to change their target prices, especially in bear markets.
HUM is trading at about 9.3% below Wall Street Analysts’ mean consensus target price of about $598, according to StockRover.com. UNH is 11.2% below its $596 target price and DHR is 13.2% below its $311 target price.
HUM is at 84% of its high target price estimate while UNH is at 82% and DHR is at 81%.
In this market, which appears to be running out of steam after a strong bear market rally, a stock’s momentum is important. The better a stock’s momentum at this point, the better it is likely to perform during the next dip or correction.
HUM has the best momentum of these three health stocks with a Stock Charts Technical Rating of 80.7, which is a strong buy rating. UNH’s 51.8 SCTR score is a hold and DHR’s 50.7 SCTR also is a hold. XLV’s 97.3 SCTR looks a bit over bought. Anything over 60 is considered a buy by market technicians.
An income trader could sell DHR 12.30.33 (25 days) expiration $245 strike (delta -.10 cash secured puts for about $1.35 per share or $135 per 100-share option. If the trade was done every 25 days for 12 months, the annualized return on risk would be about 6.7%. The strike price is 89% of the $274.23 stock price.
Traders might want the stock prices to dip before selling puts on stocks. If the stock rises or stays above the strike price until the put option expires worthless, the investor collects the premium and places the trade again, or not, depending on market conditions.
The same kind of trade could be done on puts options for HUM, UNH and XLV if those trade made more sense to a trader or if she wanted to sell puts on all four of these equities.
LINKs:
Home Page. See previous articles on other trades, stocks and watch lists. If you read several of these articles, you’ll learn how my strategy is meant to work. No guarantees. Links to useful web sites are on the lower right corner of the home page. Scroll down.
Selling in The Money Covered Calls Can Yield Big Annual Returns on Risk. By Donald E. L. Johnson
20 Ideas for Adjusting Your Stock and Bond Portfolio, by Christina Lourosa-Ricardo.
How to Beat Inflation Tax, Bear Market Tax With Dividend Stocks, Covered Calls, Cash Secured Puts, by Donald E. L. Johnson.
Wars Breed Inflation, Rising Interest Rates, Market Turmoil, By Donald E. L. Johnson.
Ways to use StockRover.com to analyze stocks
Calls vs Puts Options: What’s the Difference?
A video on how to place options trades on Think or Swim.
As always great article Donald!