Contents
Summary
- GS released results April 15, 2019 and its share price took a beating.
- I am not prepared to bet against GS and am of the opinion there is a reasonable probability the share price will rise over the next few months.
- I am currently long GS and have initiated a Bull Put Spread to demonstrate how you can gain exposure to a company if you think it's share price will rise but you are not prepared to invest additional money to acquire shares outright.
- A bull put spread allows me to benefit from my bullish outlook and know my maximum profit potential, cap my maximum loss, and know my breakeven level.
Introduction
In my January 17, 2019 Goldman Sachs (GS) article I concluded that GS was attractively valued and represented a worthwhile long-term investment despite potential losses related to Malaysia's 1MDB corruption scandal.
Fast forward to the release of GS’s Q1 results on April 15, 2019 and my sentiment has not changed.
GS is a powerhouse in the world of investing and I am not about to bet against it. It might get bruised and battered but I am reasonably confident it will still be a powerhouse long after I am no longer on this planet.
All articles to date in which I touch upon option trading opportunities have focused on situations in which I have owned the underlying shares (covered call trades). I recognize this does not help investors who are not in a similar situation so I am taking a different approach with today’s article.
GS’ shares trade for ~$202 as I compose this article. If you do not currently own GS shares and do not have $20,200 to acquire 100 GS shares then writing an article in which I discuss covered calls is going to be of little interest to you.
I, therefore, have just executed a Bull Put Spread in which I have increased my exposure to GS without acquiring additional shares to demonstrate how you can potentially employ this strategy.
Keep in mind that since I do not own the underlying shares of GS through this trade I am not entitled to receive any dividends. The manner in which I have executed the trade, however, has resulted in me collecting $835 in net option premiums (before nominal service charges).
I am fully cognizant that not all investment decisions pan out as planned. Since I am a reasonably conservative investor I want to ensure that my downside is limited if things don’t turn out as planned. So, if you’re thinking I am going to present a strategy in which to attain GS exposure which could result in substantial losses…fear not.
Although I am purchasing and selling GS options and am not acquiring an ownership interest in the company I still want to look at GS’s financial position, YTD results, and outlook.
Before reading further I highly recommend you review a comprehensive overview of GS as at February 2019.
Q1 2019 Financial Results
GS’s Q1 2019 results can be found here and its Earnings Presentation can be found here.
GS reported Q1 revenues of $8.8B, down 13% from Q1 2018 reflecting a slower start to the year relative to the robust market backdrop of a year ago.
GS continues to lead its peers in that it ranked:
- #1 in global completed M&A;
- #1 in announced M&A;
- #1 in global equity underwriting.
In addition, it posted record net interest income and debt investing and lending and record assets under supervision and investment management.
Keep in mind that GS’s results were generated in a mixed macroeconomic backdrop. In Q4 2018, GS experienced a challenging market as central banks pivoted to an accommodative policy on rate.
In the U.S., the Fed shifted from its prior path of incremental tightening to a more neutral stance and in Europe, the ECB signaled move back monetary stimulus. Central banks in Asia also shifted to more dovish rhetoric amid a backdrop of low inflation and somewhat disappointing growth. The net result was a lower volatility environment as government bonds rallied and yield curves flattened in the U.S. and Europe. With the VIX (volatility index) and other measures of volatility at near record lows, trading activity remained low.
There was also a significant slowdown in IPO activity as a direct result of the government shutdown.
Ongoing geopolitical risks, including US/China trade and Brexit negotiations, continue to add uncertainty.
Resilient macro fundamentals and rising asset prices, however, spurred client engagement later in Q1. Institutional investing clients appeared less cautious in March and GS has indicated that as it engages with corporate clients around the world, it continues to hear a strong desire to execute strategic transactions and access the capital markets while the economy is growing, market prices are favorable, and financing markets are open.
GS has indicated its backlog for IPO activity is robust.
On the strategic planning front, GS’s plan to drive long-term shareholder value consists of 3 primary objectives.
- Strengthen existing businesses;
- Diversify business mix with new services to expand opportunity set and increase the durability of revenues;
- Operate more efficiently and effectively across all aspects, including expenses, financing and capital.
The important partnership with Apple which GS (first credit card) announced about a month ago demonstrates that GS is committed to diversifying its business mix.
The key elements of this project with Apple underscores a range of major strategic growth initiatives currently underway. These initiatives include re-imagined products that address pain-points for clients, new technology unburdened by legacy systems that often slowdown innovation, digital delivery mechanisms that produce scale and efficiency, and access to large customer population.
On the Q1 conference call management indicated that in the Fall of 2018 GS began a process of re-underwriting each of its businesses, including the development of 3 year plans for the firm.
On the revenue side of the analysis, GS is assessing opportunities to grow its addressable market, enhance the client experience, and to grow wallet share.
In Investment Banking, an important outcome of GS’s review is the decision to further expand the client coverage universe. GS hired over 40 bankers, adding coverage for over 1,000 new clients, thereby increasing its footprint by about 10%.
Given this early success, GS has decided to expand the strategy and is now creating a specialized team within Investment Banking to serve new clients with enterprise values of less than $2B. The plan is to dedicate roughly 100 coverage bankers to this new initiative over time thus increasing capacity to cover thousands more clients.
A new corporate cash management platform build is advancing and once completed should open a very large revenue pool, including an estimated $5T of corporate deposits in the U.S. alone.
There is significant value in serving these ‘smaller’ clients in that it will lower GS’s deposit funding costs and will provide additional foreign exchange revenues.
This corporate cash management platform is expected to be completed later in 2019. GS will be the first to use this service and it is anticipated there will be a savings of $0.1B/annually and a reduction in operational risk. Target client launch is 2020.
On the institutional client services front, GS has identified a number of opportunities to better serve its existing client franchise and to broaden the business mix. Across Fixed Income and Currencies and Equities businesses, GS is working to deepen its penetration with institutional and corporate clients, rural financing and to increase business with systematic investors.
While GS may undoubtedly adjust its focus and footprint, it remains committed to serving clients.
GS’s reviews have identified opportunities to cut expenses and capital from certain underperforming parts of the commodities business and increase investments in others. Action has already begun to right-size various areas of the company and further refinements can be expected to occur over time.
Credit Ratings
A comprehensive recap of ALL of GS’s credit ratings, including those of its affiliates can be found here; the credit ratings that are most relevant for my purposes are those for GS Group Inc.
All long-term credit ratings for that entity are satisfactory for my purposes.
Dividend, Dividend Yield, and Dividend Payout Ratio
During Q1 GS distributed $0.306B of common stock dividends.
I have been unable to locate GS’s dividend history on its website and draw your attention to this page for such information. As I compose this article I see this dividend history webpage has not been updated to reflect the increase in GS’s quarterly dividend from $0.80/share to $0.85/share.
Following the increase in GS’s dividend, the dividend yield is ~1.68% on the basis of the current $201.84 share price.
GS repurchased $1.25B of issued and outstanding shares in Q1.
Valuation
In FY2018, GS generated basic diluted EPS of $25.53 and adjusted diluted EPS of $25.27. When I wrote my January 17th article, GS had closed at $199.09 thus giving us a diluted PE of ~7.8 and an adjusted diluted PE of ~7.88.
GS does not provided earnings guidance but at the time of my January 17th article, the current mean adjusted EPS estimate for FY2019 from 25 brokers was $24.39. Using this estimate and the $199.09 stock price I arrived at a forward adjusted PE of ~8.16. This was not much different from the forward adjusted PE of ~7.9 as at the time of my November 18th article.
I now see that the mean adjusted EPS estimate from 24 brokers is $23.47. Using the current $201.84 share price the forward adjusted PE is now ~8.6. Not as attractive as previously but still reasonably attractive from my perspective.
Option Strategy
I present the following option strategy because I:
- am of the opinion there is an opportunity for GS’s share price to rise over the next few months;
- want to demonstrate how options can be used to take a position in a company when you may not necessarily be prepared to invest a large sum to acquire a company’s shares outright;
- want to employ an option strategy where I receive money when the trades are executed as opposed to disbursing funds.
These are the trades I executed April 16, 2019:
- Sold an October 2019 $210 PUT – received $16.25/share x 100 shares = $1625.00
- Bought an October 2019 $190 PUT – paid $7.90/share = $790.00
- Net cash received from the above trades - $8.35/share = $835.00
NOTE: The above excludes nominal transaction costs.
Breakeven
My breakeven is calculated as $210/share - $8.35/share net cash received giving me a $201.65 breakeven.
GS Closes Above $210 At Expiry
By selling the $210 PUT I have given someone the right to sell GS shares to me for $210 by the October 20, 2019 expiry. By buying the $190 PUT I have the right to buy GS shares for $190 by the same expiry date.
Suppose GS shares were to close at $215 come expiry. The holder of the $210 PUT would not want to exercise their option to sell me shares at $210 since they could sell their shares on the open market at $215. These options, therefore, would expire worthless.
At the same time, I have the right to sell GS shares at $190. I don’t own GS shares in the account through which I executed the option trade and I am certainly not going to go to the open market to purchase shares at $215 only to turn around and sell them for $190. These options, therefore, would also expire worthless.
My net gain….the $8.35/share (less nominal commission) I received when I placed my trades.
GS Closes Below $190 At Expiry
If GS’s share price were to plunge to $150, for example, the holder of the $210 option would exercise their option and I would have to sell them shares at $210. GULP! I would be down $60/share or $6,000 per option contract since each contract is for 100 shares.
However, I hold the right to sell GS shares at $190. So I have to buy shares at $210, I sell shares at $190, and I am down $20/share or $2,000 per option contract. GULP!
But wait a minute! I collected $8.35/share when I wrote the contracts ($835/contract).
My loss is not $6,000 or $2,000 but rather $1,165 ($2,000 - $835). Not necessarily the desired outcome but I was able to gain exposure to GS without having to fork over tens of thousands of dollars.
If I had purchased 100 GS shares today I would have had to pay ~$20,000. If shares were to plunge to ~$150 like they did in December 2018 I would be down ~$5,184 (($201.84 - $150) x 100 shares). Sure, I would still own the shares and I would have collected a nominal amount in dividends but by using the option strategy presented I have capped my downside at $1,165.
Final Thoughts
GS shares are currently held in the FFJ Portfolio but rather than write covered calls I have decided to demonstrate how the use of options can be used when you wish to have exposure to a company where you think the share price will rise but you are not prepared to invest a sizable amount to take a share ownership position.
I have purposely selected the use of PUT contracts because I wanted to enter an option trade where I receive funds at the time of the trade as opposed to laying out money.
The trades I have placed are certainly not as conservative as the covered call option trades I have been placing where I own the underlying shares. It, however, is a far more conservative option strategy than many other strategies.
In summary, I think GS shares have a reasonable probability of rising in value and closing above the strike price of the $210 PUT options I wrote. If all works out as planned, I maximize my upside at ~$835/contract. If things go horribly wrong, however, I already know my maximum downside will be ($1,165). In addition, I know what will be my breakeven level.
I hope you found this article helpful and wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long GS.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
