Why I am Dumping my Magna Shares

Ok, I have to admit I used the word “dumping” to get your attention. This is not a bear rant on a good company but rather a strategic maneuver to create a favorable risk/reward proposition. In fact, what I will demonstrate is my rationale for replacing the stock with call options.

Here are some facts about the stock:

• Magna is currently trading near its all time new highs at $116.00 after an impressive 20 month 170% rally that started November 2012 at $43.00 a share.
• Even after an impressive advance like that, the stock does not have valuations that are astronomical with a P/E ratio in the mid teens and a dividend just over 1%.
• Magna’s growth rates have outpaced the industry average and continue to boost the earnings per share.
• Technically, the stock remains in a decisive uptrend and is showing no immediate sell signals. The pattern of higher highs and higher lows is very evident and buyers use every short term consolidation to accumulate the stock.

SO WHY AM I SELLING?

First off I am not bearish on the stock, nor do I necessarily believe that a serious drop in the stock is imminent. Rather, I am strategically adjusting my position based on the current market circumstances.

Here are some facts that I deemed important to take into account when I was assessing my situation:

1. I own my Magna shares in my RRSP, which immediately removes the variable of tax considerations.
2. While I did not buy my shares at the 2012 lows, I have made a considerable amount of profit in the recent advance. The consideration is that anyone that has been around the block in regards to the stock market recognizes that stocks don’t just go up in a straight line. Rather,it is common to have numerous corrections that check an investors resolve to remain invested.
3. The stock market as a whole is very complacent and market volatility remains historically low. While the current option prices are deemed to be the “right price”, they are structurally cheap when compared to historical comparisons.
4. The stock started the year at $80.00 a share and has advanced $35.00 through the first half of 2014 to its current $116.00 range. In addition, the stock paid a $0.412 dividend on May 28^th and is expected to pay another dividend in late August.

Now, I am not selling my shares to abandon the stock, but rather replacing my stock with call options to redefine a new asymmetric risk/reward proposition. Here is what I am doing:

• I am selling my shares of Magna at $116.00 and taking my profits in my tax sheltered RRSP.
• For every 100 shares, I am buying 1 Magna July $115 call option for $2.30.
• If I continue to like the position at the July 18^th options expiration, I will consider rolling the call to the August 15th expiration.

So what benefit have I created?

1. If the stock proceeds to rally to $120-$130 over the next month or two, I will continue to participate in further share appreciation by being able to exercise the call option and buy back my shares at the $115.00 strike price.
2. If the stock continues to advance and I do buy them back, I will take ownership before the next August 28^th dividend.
3. What I have created is a trade where, under no circumstances, will I be in a position to have lost the profits I made beyond the cost of the call option. Instead of risking an uncertain amount of unrealized profits to an unexpected market correction, I have realized all the gains and have limited my risk to the $230.00 per contract for the call options.

This may not be a consideration for all investors, but works well for the way I look and assess risk and reward in the markets.