Phillip Morris International, Inc. Diagonal Call Spread

I've long wanted to open a position in Phillip Morris International, Inc. (ticker symbol: PM). It's an incredibly robust business with about as sticky a consumer product as is possible. Unlike its domestic cousin Altria Group, Inc. (ticker symbol: MO), PM also operates in a number of international jurisdictions with far less onerous regulations, taxes and other anti-smoking governmental programs (amoral as that sounds). Furthermore, declining smoking rates in Western Europe have been offset by increases in various emerging markets. PM produces an incredible amount of free cash flow available for stock buy backs and dividends, and operates with extremely high returns on assets (in the low 20s). Following a large price decline, the stock now trades at just over 13x last year's earnings and it supports a very sustainable 5% dividend.

To gain leverage while capturing time decay, last Tuesday I purchased 5 diagonal call spreads on PM, purchasing the Jan 2011 40s, and selling the August 2010 46s, for a net debit of $2,733.97 including commissions. This spread will prove solidly profitable if the stock stays around the $46 range through August expiration, and modestly profitable above $46. (See the profit/loss chart below for a graphical description of this position. Note, however that OptionsXpress tends to inflate the implied volatility of the long-side of the spread at expiration so the actual profit potential could be less than the chart shows if volatility were to decline). This sort of diagonal call spread has the characteristics of a levered covered call and can be an appropriate source of leverage where the underlying stock has considerable price support.

If the stock does stay below $46 at the August expiration, I'll look to purchase the August calls back and sell later month against the Jan 2011s.