The last few years have been tough for the for-profit education industry. The sector has had to deal with numerous challenges including Federal investigations, declining enrollment and bad publicity. Several mediocre education companies have been acquired or forced out of business, and even the very strongest competitors have seen their stock prices sharply reduced.
Today, the landscape is looking much more attractive for the companies that are still in business. The weak environment has thinned out the competition. Schools that run primarily online class structures are now benefiting from a growing acceptance of quality online degrees. And an improving employment market is adding incentive for students to enroll (in hopes of actually landing a better job after graduation).
The for-profit education industry is a great example of an area where a put selling strategy can be put to work. This is an industry that has been beaten down and appears to have found support. It is an area where the fundamental market is improving, and I would be happy to buy this group of stocks at lower prices, should the stocks pull back a bit from here.
Since education stocks have experienced so much selling in the past several years, option premiums are relatively high. This also works in our favor because as put sellers, we are getting paid well for executing our trades.
Remember, my put selling strategy has us accepting an obligation to purchase shares at a lower level. If the stock in question declines, we might have to buy shares, and we are receiving a healthy payment -- or premium -- for accepting this obligation.
Today, I want to take a look at ITT Educational Services (ESI), one of my favorite educational companies.
Improving Expectations, Healthy Price Action
ITT Educational Services is one of the few educational companies that has managed to stay consistently profitable throughout these recent difficult years. Sure, ESI has seen its profit margins contract, but at no time did investors sustain losses on an annual basis.
ESI operates in an attractive segment of the education industry. The company offers postsecondary degree programs in the U.S., and it is relatively well diversified between different disciplines (technology, business, design, manufacturing etc.).
While the stock has experienced a tremendous decline over the past two years, investors are once again taking an interest as the environment for education improves.
ESI is very attractive for us as put sellers because although the price action has improved significantly, the day-to-day action is still fairly volatile. This causes the option contracts to trade at premium prices, which in turn gives us the opportunity to collect more cash from selling put options.
In a minute, I'll explain today's trade, which should allow us to generate 27% per year on the capital we set aside for the trade.
Fundamentally, the prospects for ESI have been steadily improving. A stronger employment environment has helped to revive enrollment for the entire industry, and analysts are revising their earnings expectations higher.
The current consensus is for ESI to earn $3.86 per share this year and $2.61 per share in 2014. More importantly, over the past 60 days, analysts have boosted their 2014 expectations for ESI by 12 cents -- a pattern that is likely to continue as the environment improves.
ESI is currently trading a bit below $30 per share. The September $25 puts are quoted near $0.83 per share, which means that we can receive $83 (less commissions) for every contract we sell.
By selling these put contracts, we become obligated to buy ESI at $25 per share, but only if the stock is trading below this level in 46 days when the puts expire. Keep in mind, this price is roughly 15% below the current price for ESI, which means that if we are required to purchase the shares, we will be buying them at a tremendous discount.
Our potential price of $25 per share represents a single-digit P/E ratio when compared to the $2.61 that analysts expect the company to earn in 2014. This is an attractive price for a company with solid profitability at the low of a fundamental earnings cycle.
If you decide to sell the September $25 puts, you should plan on setting aside $2,417 for every contract you sell. This is because you could be required to pay $2,500 for the shares, but you are also receiving $83 from selling the put contract.
Assuming the puts are not assigned, your $83 profit represents 3.43% income from the $2,417 that you set aside. Since this income is generated over a 46-day period, we can assume this type of trade has the ability to create 27% in profit per year. This assumes you can continually collect 3.43% every 46 days for a year.
To be clear, we don't need ESI to trade higher for us to capture our 3.43% over the next 46 days. We simply need the stock to close above $25 -- which gives us plenty of room for the stock to fluctuate over the next few weeks.
On the other hand, if ESI does close below $25, I am happy for us to pick up shares at a discount price. From that point, we can decide whether we want to hold the stock for a larger gain as the price moves higher, or sell calls against the position to generate additional income.
As always, I would love to hear your comments on this trade or any other setups that we have mentioned. Please send your comments to Editors@ProfitableTrading.com and mention the articles on selling put contracts.