March 30, 2015 - Time to Get Paid
Before market open Wednesday Paychex Inc. reported third quarter earnings of $169.4 million up from $160.1 million, the same quarter last year. Revenue increased 8% to $704.3 million from compared to $650.4 million the same quarter last year.
Paychex is a payroll outsourcing company that handles human resource functions for its clients. An upswing in the economy, and the increase in payrolls that accompanies it, should benefit PAYX. News of late has been encouraging for Paychex’s targeted market of small businesses with less than 50 workers. Recent declines in unemployment rates bode well for Paychex. The company’s internal IHS Small Business Index indicated small business job growth of 0.09% in January and 0.19% in February.
The Patient Protection and Affordable Care Act with its requirement that many businesses must provide health insurance to their employees is also good for Paychex. Recent research from Automatic Data Processing indicates that half of large employers in the U.S. are not prepared to comply with the regulations of the PPACA. Paychex has been able to profit from this requirement as its clients continue to buy health insurance for employees in order to remain compliant with the PPACA.
Another source of income for Paychex is interest earned on funds held for clients. This revenue has increased 4% from last year. With interest rates expected to rise in the coming year, Paychex should expect to see further revenue increases in this area.
Charts courtesy of www.stockcharts.com
In order to profit from the expected growth of PAYX, we will employ a covered call strategy. A covered call will allow us to reap the benefits from a solid stock with the additional value of premium from selling a call. Our sold call premium will provide some cushion in the case that the stock should take a downward turn. As an underlying stock, PAYX provides the proven performance that we require for our covered call, though it is unlikely to surge higher. Ideally we would expect the stock to rise, but no matter how far it rises, we should be willing to accept the possibility of selling the shares at the strike price of our call.
We will purchase 100 shares of PAYX stock trading at $49.11 and, we will sell a June‘15 $50 call for $0.85 against those shares. We pay $4,911 for the 100 shares of PAYX and receive $85 for the call option. That means we have a total investment of $4,826, or $48.26 per share. Our target return for this trade is 3.8% over 85 days or 16.31% annualized.
If, at expiration, PAYX is above the strike price of $50, the call will be assigned and we will sell the shares at $50, which is slightly more than we paid initially. Since we received that $0.85 per share credit up front, our actual cost basis is $4,826, which means selling at $50 gives us a profit of $1.74 per share.
If the price of PAYX is below $50 at expiration, our sold call will expire worthless and we will get to keep both the credit we got for selling it and our shares.
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