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Wednesday, April 28, 2010

Establish Perfect World Co. Ltd. Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Perfect World Co. Ltd.(PWRD) as follows:

04/28/2010 Bought 400 PWRD @ $34.75
04/28/2010 Sold 4 PWRD May2010 $35.00 Call Options @ $1.55

Perfect World Co., Ltd. engages in the research, development, operation, and licensing of online games primarily in the People's Republic of China. The company's 3D massively multiplayer online role playing games (MMORPGs) include Perfect World, Legend of Martial Arts, Perfect World II, Zhu Xian, Chi Bi, Hot Dance Party, Pocketpet Journey West, Journey to the West, and Battle of the Immortals. In addition, a major new game, Fantasy Zhu Xian, was released in October 2009 and has been favorably received; and two new games (Forsaken World and Dragon Excalibur) will be released in the second quarter of 2010. These games are important growth drivers and should continue the company's normally impressive successes with their new game releases.

Perfect World is the 4th largest online gaming company based in China. Online gaming represents approximately 50% of total online services revenue in China, and PWRD is very focused since virtually all revenues are generated from their games. Perfect World is known for their highly innovative games. In their relatively short six-year history, they have established a strong sales base (over $300 million in 2009) and a strong customer base -- now exceeding one million average concurrent users(ACU). In addition, they are the leader in exporting Chinese online games worldwide, although exports currently represent only 10% of revenues. They are well-established in the U.S. and are now beginning to expand to Europe.

Perfect World's stock has declined substantially since its 4th quarter earnings release when its profit did not meet expectations. This occurred largely because the profit margin dropped four percentage points as a result of higher marketing expenses (in support of Fantasy Zhu Xian release). Yet PWRD's profitability (as measured via return-on-equity) is expected to continue to exceed 30% this year. This advisor believes the price decline has been excessive and that Perfect World now represents a compelling investment value. Moreover, PWRD covered calls provide an especially attractive investment vehicle now because of the currently available high options volatility that has resulted from this recent stock price decline. This provides a nice options income benefit to us options sellers and thus a very attractive return-on-investment potential for this investment. Perfect World is matching China's total online gaming industry annual growth rate of 30%+, and it is estimated that this trend will continue in 2010 and 2011 for PWRD. But based on its estimated 2010 earnings, PWRD is value-priced with its stock currently trading at a Price/Earnings Ratio of only 9.5 -- well below the P/Es of 14 and above for its major competitors. The potential catalysts for a significant price appreciation in PWRD includes: (1) continually improving gaming quality; (2) strong game development pipeline; (3) continued overseas expansion plans; and (4) compelling financial valuation metrics.

As shown in the "Buy Alerts" spreadsheet below, PWRD has a 'Total Points' rating of 17.24 which substantially exceeds the Covered Calls Advisor's minimum investment threshold of 15.0 points:

Note: For expanded view, left click on the spreadsheet above.

Some possible overall performance results(including commissions) for the PWRD transactions would be as follows:
Stock Purchase Cost: $13,908.95
= ($34.75*400+$8.95 commission)

Net Profit:
(a) Options Income: +$608.05
= (400*$1.55 - $11.95 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If stock price unchanged at $34.75):
-$8.95 = ($34.75-$34.75)*400 - $8.95 commissions
(c) Capital Appreciation (If exercised at $35.00): +$91.05
= ($35.00-$34.75)*400 - $8.95 commissions

Total Net Profit(If stock price unchanged at $34.75): +$599.10
= (+$608.05 +$0.00 -$8.95)
Total Net Profit(If stock price exercised at $35.00): +$699.10
= (+$608.05 +$0.00 +$91.05)

Absolute Return if Unchanged at $34.75: +4.3%
= +$599.10/$13,908.95
Annualized Return If Unchanged (ARIU) +65.5%
= (+$599.10/$13,908.95)*(365/24 days)

Absolute Return if Exercised at $35.00: +5.0%
= +$699.10/$13,908.95
Annualized Return If Exercised (ARIE) +76.4%
= (+$699.10/$13,908.95)*(365/24 days)

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