Daily Stock Market Equity and Options Trading Commentary

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Tuesday, June 30, 2009

Life Takes Visa. When Will the S&P 500?

In recent blog posts I've talked about the DOW effect, Russell effect, so I decided I would devote this post to the S&P effect. The S&P 500, much like the DOW has a committee which selects the stocks in the index. I believe it's only a matter of time before Visa (V) is added to the S&P 500. I believe this because Visa is the last credit card giant not listed in the index, not to mention Visa is larger and more profitable than all four of the similar companies currently listed in the index. These companies are: American Express (AXP), Capital One (COF), Discover Financial (DFS), and (Mastercard (MA). Visa's current market cap is actually bigger than any two of the four added together. The table below is each of the companies listed above ranked by market cap.
Company Market Cap
Visa Inc 52,684,342,094
American Express Co 27,135,604,733
MasterCard Inc 21,644,275,337
Capital One Financial Corp 8,661,328,948
Discover Financial Services 4,946,050,706

When a company is added to a benchmark index like the S&P 500 the stock usually gains strength and popularity. The reason behind this is there are a lot of funds which start accumulating shares of the stock added as they want to track the performance of the S&P 500.

I started paying attention to the S&P effect back when it was announced on mid day March 23, 2006 that Google (GOOG) was going to be added to the S&P 500 on March 31, 2006. I noticed Google popped over 9% after the news broke, and rose by over 7.5% the next day on the news, and continued to rally until the most recent market downturn.

Year to date there have been 11 additions (equally 11 deletions) to the S&P 500 index. To track the recent performance of how stocks react to being added to the S&P 500, I have selected the 11 stocks added this year, and calculated their % change the day it was announced that they were going to be added to the S&P 500 index (usually announced after hours, 1 week prior to the add date), and their performance since the announcement (by now all 11 have joined the index). The S&P 500 announces these changes before the company is added to the index unlike the Russell 3000, therefore the stocks will usually experience a great amount of buying on the news versus when it is actually added. I could not find the exact dates the news was released for all 11 of these companies, so for those stocks I could not find the date the news was released, I use a time of 1 week before the stock was added to the index.

Company Ticker Date Stock Performance

Day Added Since Added
DeVry Inc. DV 6/8/09 5.00% 12.83%
FMC Technologies Inc. FTI 6/4/09 6.91% -3.47%
Denbury Resources Inc. DNR 4/1/09 0.12% -9.24%
Time Warner Cable Inc. TWC 3/27/09 -5.05% 16.65%
O'Reilly Automotive Inc. ORLY 3/26/09 1.80% 8.80%
Northeast Utilities NU 3/16/09 1.63% 13.36%
Ventas Inc. VTR 3/3/09 9.62% 34.87%
Hormel Foods Corp. HRL 3/3/09 2.66% 8.11%
Diamond Offshore Drilling Inc. DO 2/25/09 1.85% 37.36%
Health Care REIT HCN 1/29/09 3.99% -8.04%
Iron Mountain IRM 1/5/2009 13.41% 44.98%

To get a better idea of how Visa may react, we can look at Mastercard which was added to the S&P 500 on July 17, 2008, however it was announced after hours July 10, 2008. The stock quickly rose almost 5% after hours, but finished the next day of trading higher by 1.64% following the announcement. The shares rose higher by almost 14% by the day they were added, which happens to be the current 52 week high (290.96 on July 17, 2008). Mastercard is down 33.41% since it was added, but given the market we've had since July 2008 that is certainly understandable.

So if life takes Visa, then why not the S&P 500? I think it's only a matter of time before the king of credit cards gets added to the index. I have been accumulating Visa for a long time. Getting a spot in the S&P 500 is not my reason for investing in Visa, but it will be a bonus when they do get added to the S&P 500. I'll put my money on Visa because one it's a great American company (and icon), and two I think if (and it's also only a matter of time) retail rebounds (consumer confidence increases and people spend money) in the U.S., Visa is sure to benefit from it. I would buy Visa below 60 a share, which would put a dividend yield of 0.7% which isn't too bad considering they are expected to grow earnings by 25% over 2009, and 19% in 2010.

Another way to Invest in Visa: Using Leap Call Options

Another way I've been investing in Visa is buying the Leap 2011 call options. When Visa was in the low 40's early this year, I purchased several in the money call options for the January 2011 40 strike for less than $800 per contract. Today these same contracts can be sold at a bid of $2250 per contract. I do not plan on selling anytime soon as I have over 550 days until expiration, but I may look at selling half of the contracts out for the same expiration at a higher strike (also known as a call spread). Today I could buy the January 2011 60 strike call options for roughly $1300 per contract. Visa is at 62.26 per share, which puts this option in the money by $2.26, in order to break even from this position (assuming one waited until expiration) Visa would need gain 18.3% by January 2011 (this assumes Visa keeps their dividend steady, which would pay out 63 cents over this period).

So breaking this down one could open a long position with 100 shares of Visa today for $6,226, or the rights to 500 shares of the stock at $60 until January 2011 for roughly $6500. I think Visa is capable of getting to $100 by January 2011, but being conservative I'll take the current 52 week high, which is $82 a share. Let's say Visa is at $82 a share come January 2011 and I decide to get out of my position. If I opened a position with 100 shares of Visa I would have made a profit of $2,037 or 32.7% (includes dividends). If I opened 5 option contracts for the Visa January 2011 $60 strike I could exercise the options and purchase the stock on that day for $60 a share. This strategy would give me a profit of $4,500 or 69.2%. To learn more about options and opening a position like this check out my option E-Books.

This is a bullish strategy and note that if Visa is at $64.99 per share or less at expiration 100% of the investment will be lost, while a slight gain would have been made by purchasing the common shares.

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