DGI Adventure 07-21-16 Sold Cash Secured Put + Investment Thesis – Interactive Brokers (IBKR) – $33.00 strike – Aug 19 Expiration

This trade was executed yesterday 07/20/16.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article.

Dividend Cycle

IBKR will go ex-dividend at the end of August. The dividend payout will likely be $0.10/share, which is what it’s been since 2011 when the company first started paying one.

This isn’t exactly a classic dividend growth play. Maybe they’ll start growing their dividend in the future, but so far that doesn’t appear to be one of management’s top priorities. That’s okay. It doesn’t all have to be about dividend growth you know…

This trade will expire before the ex-dividend date, and the premium is just $0.05/share shy of a full year’s worth of dividend payouts.

Investment

The QC (Quantitative Case)

Okay I agree that’s kind of a lot of yellow. Revenue growth is disappointing, and EPS is great over the last 5 years but not 10. With as much exposure as they have to various market forces…those metrics are kind of…lumpy (see below).

Dividend Cushion is N/A but not yellow because I’m not really worried about dividend growth, and anyway it would probably be like 50 because of all the “cash” on the balance sheet. But that’s “cash” in the GAAP sense of the word,  not in “the available to make investments or pay dividends” sense of the word. They use it to make money sure…but they can’t just give it back to shareholders.

They make plenty of free cash flow and have a conservative balance sheet for what they do. The quantitative stuff is fine it just looks weird because they’re not the kind of plain jane  company those type of metrics are for. They’re more like a hybrid of a bank and a technology services company.

SPL (Strike Price Logic)

I really wanted a $32 strike, but I couldn’t get over a 12% annualized rate at that strike. However, that kind of premium was available at $33, so I took it. They announced earnings after market close on Tuesday, and Mr. Market had a conniption fit, selling off shares to the tune of 7% at one point during the day yesterday.

It’s kind of funny that there was such a negative reaction in light of the fact that earnings beat expectations by 14%.  Mr. Market was upset because the “market making” segment of the business was way down YoY.

Similar to WFC, the order book for put options seemed pretty balanced even though the stock was down so much for a single session. Either other folks like me were looking for long exposure, or traders had bought puts in anticipation of a negative earnings reaction and were now trying to cash in. I suspect a little bit of both, but clearly the earnings related volatility was already priced into the options market.

QWaF (Qualitative Warm and Fuzzy)

Okay, I’ll admit…this one is almost as much about the metaphysical appeal of buying Interactive Brokers stock in an Interactive Brokers account. There is a school of thought that says to invest in the companies whose products you like and use.

That can be a little dangerous if that’s the ONLY reason, and there isn’t any other due diligence. But it’s not like a totally terrible school of thought.

I am a very happy customer. I am seriously considering moving more accounts over to IB. I believe it is by far the best value brokerage platform on the planet, and I think they are extremely well positioned to benefit from the sea change towards robo-advisors which is about to get huge. For how much cash they have in treasuries, they should also benefit from a rising rate environment which will eventually happen dammit.

Their plan for the market making business is still evolving, but they have a lot of options because they have a ton of capital.

I highly recommend reading the earnings transcript. Maybe I’m just weird, but that doesn’t make me want to sell, it makes me want to buy. Mr. Market is funny.

CPR (Cold and Prickly Risks)

Speaking of which, they’re pretty exposed to Mr. Market. They have currency exposure, bond exposure, stock exposure. That exposure can make their numbers bounce around a little bit, and Mr. Market doesn’t like that…even though he created it.  For example, they have to mark their treasuries to market, even though they plan to hold them to maturity. Banks don’t have to do that, because banks get to make up shit in the GAAP universe. So one quarter they post a loss on their treasuries, the next quarter it’s a huge gain. If they were a bank they could ignore imaginary cost basis bucks, but they’re not a bank so earnings are lumpy. Is that really a risk or just an idiosyncrasy? I’ll let you decide.

They use all this various exposure to boost income. It helps keep the cost of trades down. Their trades are so cheap you wonder how they make money on them. The answer is simple. Volume.

Boy do they execute a shit ton of trades. If you’re going to be a low cost leader, you need volume, and you need (in this day and age) the technological advantage over your competitors to increase that volume. If they don’t increase volume, they’re just spinning their wheels…and that’s bad. 

To increase that volume, they need to continue to increase market share, and fortunately that is happening in a big way. Especially in Asia.

I like the prospects here, and the price is attractive compared to historical earnings and cash flow. 

Also it gives me metaphysical joy to trade in IBKR on their own platform.

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