The Curious Case of Eastman Kodak Future

by admin on March 10, 2009

Okay, bear with me on this, because it might get a little complicated. I'll try to explain a little bit of the lingo as I go along. I remember a bit of this back in the days when I used to trade stock - or I should say, when I used to have stock to trade.

As of March 10, 2009, the share price of Eastman Kodak closed at $2.30. Yeah, yeah, it's down from about $20 from a year ago, cry me a river, at least you didn't buy any frickin' Nortel, that turkey has gone to dinner table and its bones boiled to make soup stock.

Here is the interesting bit: to buy a put on Kodak store for January 2010 at $2.50, it costs you $1.05, to buy a call it costs 70 cents (at $2.50).

Now in case you did not participate in the high-tech bubble of the early 2000s, and you don't know what a put and a call is, I will explain. If you wanted to buy an option to sell one Kodak share in January 2010 at $2.50, it would cost you $1.05. If you wanted to buy an option to sell one Kodak share at $2.50 in January 2010, it will cost you 70 cents.

So what, you might say, every little-guy investor in the Northern Hemisphere has gotten raped this year. Do I look like I want to take chances. No, most likely you don't want to be buying calls or puts. That's very risky. But somebody out there is buying puts and calls on Kodak. I mean, there's some volume on that. And for every buyer there must be a seller. The last statement has implications.

Let us say that you buy one thousand shares of Eastman Kodak at $2.50. This costs you $2500 (I'm not including brokerage fees for the sake of simplicity). Then you turn around and sell one thousand puts at $2.50 for January 2010 netting you a gross of $1050. And you sell one thousand calls for January 2010 for $700.

Right now Kodak is showing as paying a dividend of 50 cents per share so in theory you should net $500 over the coming year but let's be realistic, Antonio's gonna hammer that dividend down to zippo in the next quarter or two. That's already priced. Okay, you put out $2500 and you got back $1750, that means you are out $750 plus brokerage fees.

Now let's fast-forward to January 2010. Let's say the stock closes at $2.50. Both the put and the call option expire as they are worthless. You made $1750 or a 70% return on investment. Okay, instead of $2.50, it closes at $3.50. The put option expires worthless but the call (which you sold) is worth a buck. So you make $1050 or a 42% return on investment. PLUS  you gotta think if Kodak goes up a buck in the next twelve months, then maybe the dividend won't get cut so there is more upside there too.

Okay, here is the bad news: Kodak goes belly-up before January 2010. You are out the $2500 and only have the $1750 for a return of  minus 30%. Note however, you can steps to cut your losses if you see Kodak is going down the tubes. That is to say, if Kodak goes to 50 cents, you could probably cover your calls for a lousy 10 cents ($100) and then dump the shares  for 50 cents or 500 bucks. That cuts your losses to minus 14 percent or $350.

I would estimate your break even (again, not including brokerage fees) is about 80 cents. That is to say, if Kodak closes in January 2011 at 80 cents, then you can sell for $800 which you add to your $1750 giving you a total of $2550 or a net gain of  about 2%.

Note: The puts and calls for October 2009 right now are almost priced the same as January 2010. Curiouser and curiouser. This means that if Kodak could keep it together for another seven months, then somebody could make 70% return a little more than half a year, with a maximum loss of 30%.

Interesting. Yes, the brokerage fees could eat into that margin. But interesting all the same. It's past midnight here (again). I need to go to bed.

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