Tariff Action Makes Paper Stocks Look Attractive

  • August 13, 2001
  • Jon Najarian

The US decision to put 19% import tariffs
 on Canadian soft lumber
will raise the cost of shipping to the US for Canadian producers by about $60
per 1,000BF and raise the floor under lumber prices, Morgan Stanley told
clients overnight.

   

Don’t count homebuilders or homebuyers among those applauding the move, as
the average consumer may be facing additional costs of up to $1,000 to the
price of building a new home. Traders will be keeping a close eye on how
things transpire in the wake of the ruling, as the housing sector has been
among the strongest sectors in all of 2001.

   

Based on the tariffs and the fact that the only paper stocks with any real
option volume are Georgia Pacific
(
GP |
Quote |
Chart |
News |
PowerRating)
and International Paper
(
IP |
Quote |
Chart |
News |
PowerRating), we began
to search for longer-term bullish positions. However, the absurdly low
volatility of both IP and GP
options (both in the low 30% range) ruled out covered writing as an acceptable
risk investment.

   

Therefore, we focused on 2 Call Vertical Spreads:

   

With IP trading for $39.50, a trader could
buy the January 37 ½ Calls for $4.50 and sell a like number of January 45
Calls for $1.20. Thus, he’d own that 7 1/2 point Call Spread for $3.30.
Given that the intrinsic value of the long $37.50 calls is $2 (with IP trading
for $39.50), he will only be paying a time premium of $1.30.

   

For those who prefer Georgia Pacific, they
may want to consider buying the January 35 Calls for $4 and sell a like number
of 40 Calls for $1.85. In other words, that investor would have paid $2.15 for
that 5-point Bull Call Spread, with an intrinsic value of $.625, as GP is
trading for $35.625.

   

Neither spread is going to set the world on fire, but owning the upside for
paper and building products for so little money seems like a reasonable place
to park some money.