Jonson & Johnson is a healthy blue chip dividend aristocrat, but the shares just sold off 6.2% on Friday on overblown fear related to an irrelevant trace of asbestos found in a lot of its baby powder. Further, the shares have lagged the overall market this year as the entire healthcare sector has been dragged down by widespread pressure on drug prices. Nonetheless, JNJ remains healthy, and the options market is currently offering some very attractive premium income on the shares thanks to overly fearful shortsighted investors. This report explains why we like the company and why we like the trade. More specifically, we believe this is an attractive trade to place today, and potentially tomorrow, so long as the share price doesn’t move too dramatically before then.
The Trade:
Sell PUT Options on Johnson & Johnson (JNJ) with a strike price of $120 (5.5% out of the money), and expiration date of December 15, 2019, and for a premium of $1.90. That’s an extra 9.5% income for us on an annualized basis (1.90 / 120.00) x 6 months). If the shares get put to us before the options contract expires then we're happy to buy the shares of this big dividend aristocrat (3.0% yield) at the lower price of $120.00. And if the shares don't get put to us, we still get to keep the extra income we generated no matter what.
Your Opportunity:
We believe this is an attractive trade to place today and potentially Tuesday as long as the price of JNJ doesn't move too dramatically before then, and as long as you’re able to generate annualized premium (income for selling, divided by strike price, annualized) of approximately 8% to 12%, or greater.
Our Thesis:
Johnson & Johnson is a healthy healthcare company operating across three main segments (consumer products, pharmaceuticals and medical devices).
And the company just announced another quarter of very strong earnings last week.
Nonetheless, the share price has lagged the market this year as the overall healthcare sector has been dragged lower by the government’s pressure (e.g. President Trump’s) on drug prices, as well as Friday’s news of a JNJ recall on a lot of baby powder because trace amounts of asbestos were found.
First, regarding the healthcare sector’s underperformance, JNJ is a bit of a “baby thrown out with the bathwater” because even though pharmaceuticals is only about half of the company’s sales (see earlier graphic) the shares have sold off right along with the entire healthcare sector.
Second, according to the asbestos news, a trace amount (“less than or equal to 0.00002%”) of asbestos was found in a single batch of baby powder, thereby triggering the recall, and also triggering a lot of market fear and the subsequent sell off in the shares. Keep in mind, JNJ’s products are constantly monitored and approved by the FDA, and the trace amount found in the single batch is very insignificant (you can find trace amounts of all kinds of things in just about anything).
Nonetheless, market fear has caused the sell off, and that has created this opportunity (options premium income increases when fear is higher). And the fact that the healthcare sector is struggling, JNJ has been receiving bad press related to the opioid crisis and the overall healthcare sector has been hurting, have all combined to set up this attractive trade. We already own shares of JNJ, and would be happy to own more at the lower price.
Important Trade Considerations:
Two important considerations when placing options trades are upcoming earnings announcements and dividend dates because they can increase volatility and dramatically impact the value of your options contract in unexpected ways. And in the case of JNJ, only the dividend is a significant factor (because JNJ just announced earnings recently, and won’t announce again until after this contract expires). Regarding the dividend, JNJ will go ex-dividend again on November 25th (that’s the date the shares start trading without the dividend payment). However, even after factoring in that $0.95 dividend, we view this trade as attractive. Specifically, the worst case scenario is the shares of big-dividend blue chip JNJ get put to us at an even lower price—and we’d be happy to own more shares for the long-term).
Cash Secured Or Margin:
If you're going to place this trade, you'll need to keep enough cash in your account to cover the cost of the shares if they do get put to you. Options trade in lots of 100, so you'll need to keep at least $12,000+ of cash on hand for each contract trade ($120.00 strike price times 100 shares). The other alternative, if your account is approved for margin, you don't need to keep the cash on hand, but if the shares do get put to you then you'll buy them with borrowed money (on margin), and there is a cost to that (currently around 2.7% annual interest charge at Interactive Brokers, for example).
Conclusion:
Johnson & Johnson’s dividend has grown every single year for over 50 years, and we don’t expect that trend to stop. The company is attractive (it’s a highly profitable “wide moat” business), and the share price is compelling. Rather than buying more shares outright, we like this options trade because it generates attractive upfront income for us (that we get to keep no matter what), and it gives us the opportunity to own more of these attractive shares, at an even lower price, if the shares fall far enough and get put to us before the options contract expires in December. Overblown, short-term, market fear has increased uncertainty, increased volatility, increased the amount of premium income available in the options market, and created this attractive income-generating trade opportunity.