Finding Value!

This is shaping up to be a bad quarter on a macro basis, with flattening growth curves all around. Credit issues dominate in Europe and the US. However, a credit downgrade doesn’t mean an equity downgrade. There are burgeoning economies around the world that have near junk ratings but have roaring equity markets.

The reason is that debt and equity are separate and distinct investment vehicles, each with its own nuances. Keep in mind that since 2008, corporate profits have been in strong recovery. Even with this global sell-off, profits have been stable and for many global S&P companies, have been downright upbeat.

Now is the time to dig deep into quality companies where you can find good value. For example, Brookfield Asset Management Inc. (TSX: BAM.A, recent price $26.03) which recently reported a ninefold profit increase, is a quality company that has been taken down with the rest of the market.

Is that reasonable? Has the crisis in Europe or the US Treasury downgrade somehow caused Brookfield’s management to lose their ability to manage their massive real estate, infrastructure, and energy holdings? No, of course not! Are we on the verge of a global financial system collapse of the kind we faced in 2008? Not even close.

If you are one who believes that companies like Brookfield, with its global footprint, have become deeply oversold, take a look at some bullish option positions. A couple of ways to play this; 1) writing cash secured in-the-money puts or, 2) buying slightly out-of-the-money calls.

The short put strategy has merit because option premiums have risen sharply reflecting the volatility in global markets. Writing options allows you to capture that premium. Selling the Brookfield October 30 puts at $2.42 per share has merit if you believe premiums are overstating the risks associated with the company.

The long call strategy allows you to participate in a rebound with limited risk. The most you can lose is the cost of the call, although that cost is higher because of the increase in volatility. Buying the Brookfield October 29 calls at $0.95 would profit if the market starts reflecting the value of the Brookfield franchise.