3TL Alert: Aon plc (AON)

By Jim Pearce • October 6, 2017

TRADE INSTRUCTIONS
Date: October 6, 2017
Name: Aon plc
Symbol: AON
Type: Short Sale or Long Put
Limit: N/A

Reminder: 3TL stand for 3-Time Loser, which means this alert if for a stock that I believe is at risk of declining in value soon so the appropriate trade would be either a short sale or long put, but DO NOT GO LONG! And since you can play it a number of ways with put options in terms of strike prices and expiration dates I’m leaving it up to each of you to decide what, if anything, you want to do with it. For that reasons, it will not be tracked in our portfolio. This trade is not a substitute for our usual buy recommendation but is simply an extra “bonus pick” for you to consider. Here’s why this stock qualifies as a 3-Time Loser according to my system.

TRADE RATIONALE
AON is a global insurance giant that has seen its share price increase 30% during the past year. Its stock is now valued at 18 times forward earnings, which is pricey for a financial service company. In addition, it earns the lowest possible score of 0 from my IDEAL Stock Rating System due to its flat cash flow growth and paltry dividend yield.

Why do I think AON is ripe for a fall now? Its second-quarter earnings report revealed that reinsurance was its fastest-growing revenue segment (+6%) this year, which may prove costly as the company admits in its recent “Global Catastrophe Recap” report. Natural disasters have caused enormous financial damage in many of the markets Aon serves over the past two months and no one, including Aon, has dared to estimate how much it will cost to pay out on claims.

The upshot is an insurance stock priced for perfection that may be on the hook for a currently unquantifiable amount of reinsurance claims. We’ll soon find out how bad the damage is when the company reports third-quarter results on October 27. Of course, the company won’t be able to provide an exact amount but it most likely will set aside an additional amount for claims in excess of what is already withheld for that purpose.

If I’m wrong, I don’t see the stock going much higher now that the Fed has admitted that its initial inflation estimate may have been too aggressive. Insurance companies are the ultimate interest rate arbitrage business model, buying bonds with premium income and using the interest income to pay off claims. If interest rates don’t move up as fast as analysts assumed in their pricing models then AON may already be overvalued.

And if the company includes forward guidance reducing full-year earnings (and possibly next year’s earnings) then look out below! A forward P/E of 14 is not out of the question under that scenario, in which case AON could be looking at 25% drop in share price.

Note: AON is optionable.

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Derek: Las Vegas, NV

10/06/17 ‐ 3:34pm ET October 6, 2017 at 3:34pm ET

Thanks for the bonus play Jim! Opened a few put debit spreads on AON.

BTO: $145 Nov Put
STO: $140 Nov Put

Net Debit $1.20
Max ROI: 316%

Derek

Benny K

10/11/17 ‐ 8:29am ET October 11, 2017 at 8:29am ET

Hi Derek,
Wanted to participate in Jim’s latest 3TL so decided to dip my toes in the water and try my first debit put spread. I mimicked your trade and was wondering if you have any advice as to exit strategies or what to watch for as expiry approaches.Have been trading calls and covered calls so this is a new animal for me. Any advice would be greatly appreciated.
Thanks,
BennyK

Derek: Las Vegas, NV

10/11/17 ‐ 12:59pm ET October 11, 2017 at 12:59pm ET

Hi Benny,

I will decide what to do with the trade after earnings on 10/27. The goal is for the stock price to be below $140 by expiration, if so then the spread will automatically be exercised and assigned allowing us to collect $500 p/spread. Max profit potential is $500 p/spread minus the initial debit. If the stock price doesn’t drop below $140 then I will close the trade or roll it, what I choose to do will depend on if the spread is profitable or not. I will post again after earnings.

Derek

Benny K

10/11/17 ‐ 1:55pm ET October 11, 2017 at 1:55pm ET

Thanks Derek,
That is very helpful. I’ll wait for the earnings report as well and watch for your post.

Derek: Las Vegas, NV

10/30/17 ‐ 3:54pm ET October 30, 2017 at 3:54pm ET

We have 18 days until expiration, the trade is looking good so far and I’m not closing or adjusting at this point.

Derek

Benny K

10/30/17 ‐ 4:24pm ET October 30, 2017 at 4:24pm ET

Thanks for the post Derek. It is looking good so I will watch and wait as well.

Benny K

11/03/17 ‐ 11:35am ET November 3, 2017 at 11:35am ET

Just wondering Derek. If I want close my spread do I simply BTC the 140 put and STC the 145 put or am I leaving too much money on the table at this point?

Derek: Las Vegas, NV

11/03/17 ‐ 12:50pm ET November 3, 2017 at 12:50pm ET

Hi Benny,

Yes, you would BTC and STC, my profit target is 85% of the potential profit so I set a limit order (GTC) for 85% of the profits, price of $4.43 credit. If the stock starts to drift upwards I will close it out for at least 50% of the profits. You never go broke taking profits, so if you hit your profit target there’s nothing wrong with closing it out.

Derek

Benny K

11/03/17 ‐ 2:43pm ET November 3, 2017 at 2:43pm ET

Hi Derek,
Thanks for walking me through this one. I decided to close it out for a 186% profit. Not bad for 24 days. I would be interested to hear how your trade goes. I am a little confused as to how how you arrived at the $4.43 credit. Thanks again

Derek: Las Vegas, NV

11/03/17 ‐ 3:07pm ET November 3, 2017 at 3:07pm ET

Nice, can’t go wrong with 186% return!

My brokerage account allows me to set orders by percentage of profits, so I just selected 85% of profits and it set the limit order price for me.

The math would be $380 x 85% + $120= $443

Derek

Benny K

11/03/17 ‐ 7:52pm ET November 3, 2017 at 7:52pm ET

Hi Derek,
Gotcha, Thanks
Benny

Jim Pearce

11/03/17 ‐ 8:39am ET November 3, 2017 at 8:39am ET

Hey Derek, you may want to take a look at that spread this morning given AON’s plunge below $140 late in the day yesterday.

Derek: Las Vegas, NV

11/03/17 ‐ 11:07am ET November 3, 2017 at 11:07am ET

Thanks Jim, yes I’m watching closely.

Derek

RockS

11/09/17 ‐ 12:06pm ET November 9, 2017 at 12:06pm ET

Hey Derek,
I did the same trade as you, on AON and have been watching the price creep (more like jump today $142) back up despite the extra news from Jim Pearce that should have hit it down some below the $140 mark. Probably have some OFI in my not to want to close ahead of expiration on 11/17,and Jim Fink’s prediction 11/7 that the next two weeks are weakest of Nov. Wondering what your strategy is now? Thanks, RockS

Derek: Las Vegas, NV

11/09/17 ‐ 12:24pm ET November 9, 2017 at 12:24pm ET

Hi RockS,

I have no plan in place at this time, I closed the trade for over a 200% return. You really only have three choices; hold, roll or close. Remember, some profit is better than no profit…

Derek

RockS

11/09/17 ‐ 2:33pm ET November 9, 2017 at 2:33pm ET

How right you are! Comes down to 3 doors and thanks for your reply. Congrats on the 200%!

HowieA

10/06/17 ‐ 4:20pm ET October 6, 2017 at 4:20pm ET

BTO Apr 145 Put @ $5.30.

HowieA

11/03/17 ‐ 12:01pm ET November 3, 2017 at 12:01pm ET

Placed STC OCO order at $10.00 or Trail Stop @ -3% (now at $9.20). Thanks for the trade idea Jim. Howie

Peter G

10/09/17 ‐ 1:25am ET October 9, 2017 at 1:25am ET

Hi Jim,

Decided to jump in on this trade also with a Call Credit Spread with reasonably conservative strikes:

AON 20180119: BTO Call $150 STO Call $145 Net Credit $2.70

DR083157

10/20/17 ‐ 1:34pm ET October 20, 2017 at 1:34pm ET

Do you still think this is a good short?

Jim Pearce

10/20/17 ‐ 1:41pm ET October 20, 2017 at 1:41pm ET

Yes, I do. Until we see the forward guidance included in its quarterly report scheduled for release next week I have no reason to change my thesis described above.

DR083157

10/20/17 ‐ 1:49pm ET October 20, 2017 at 1:49pm ET

I decided to tiptoe in with 2 contract spread. I break even at roughtly $148.60.

10/20/17 4809 Option
Buy Open
Sell Open
Buy Open
Sell Open
2
2
2
2
AON Nov 17 ’17 $150 Call

AON Nov 17 ’17 $145 Call

AON Nov 17 ’17 $150 Put

AON Nov 17 ’17 $145 Put

Net Credit Day 2.57 3.11
6.94
1.99
0.77
Executed Portfolios

Jim Pearce

11/03/17 ‐ 8:41am ET November 3, 2017 at 8:41am ET

DR – take a look at that spread today, we got a big drop out of AON late yesterday so you should be in pretty good shape.

Jim Pearce

10/27/17 ‐ 10:03am ET October 27, 2017 at 10:03am ET

Success! As I suspected, AON is down strongly this morning after reporting disappointing quarterly results (https://finance.yahoo.com/news/aon-reports-third-quarter-2017-103000773.html). If you dig through the numbers (and footnotes), it is apparent that the company is engaging in a bit of Income Statement chicanery to mask the fact that its net operating cash flow is going the wrong direction. The stock is down $5 this morning and approaching its lower Bollinger Band at $144.77 so short-term options traders may want to take a hard look at their positions today.

Dramatic License

10/27/17 ‐ 10:04am ET October 27, 2017 at 10:04am ET

Great start to the slide. Debating this one, but feel like I need to ride this out a bit more. We’ll see how the day progresses.

Jim Pearce

10/27/17 ‐ 10:11am ET October 27, 2017 at 10:11am ET

If it breaks through $144 the next support level is around $138.

Dramatic License

10/27/17 ‐ 10:25am ET October 27, 2017 at 10:25am ET

$138 would be great for my options spread. 🙂

Jim Pearce

11/03/17 ‐ 8:38am ET November 3, 2017 at 8:38am ET

Hi DL, looks like your wish came true yesterday so I hope you cashed out your spread. Nice trade!

Dramatic License

11/03/17 ‐ 10:04am ET November 3, 2017 at 10:04am ET

I cashed out a bit early, but still did pretty well considering it was only held about a week or two!

Dramatic License

10/30/17 ‐ 2:44pm ET October 30, 2017 at 2:44pm ET

The slide continues. Hope it keeps going. One of the few bright spots in my portfolio today.

Jim Pearce

10/30/17 ‐ 4:18pm ET October 30, 2017 at 4:18pm ET

AON closed beneath its lower Bollinger Band today (at $144.44), so will be interesting to see if can get back above it tomorrow. If not, then it should keep dropping the remainder of the week. When will the shorts start piling on?

Jim Pearce

11/06/17 ‐ 9:59am ET November 6, 2017 at 9:59am ET

For those of you hanging on to your short plays on AON, this announcement over the weekend could cause further trouble for them later on: https://finance.yahoo.com/news/uk-financial-services-watchdog-investigate-121532992.html,

RockS

11/16/17 ‐ 5:36pm ET November 16, 2017 at 5:36pm ET

Hey Jim,

So I don’t know if that news above finally seeped in, or what, but today 11/16, the day before expiration AON commenced to dropping. It closed below yesterday’s close, fell well below the MAC line and several tiers of Bollander bands. I have held the 140/145 debit puts, so if anyone else is out there in the same boat, keep a sharp eye on it–maybe tomorrow’s expiration can yet be grand. The stock closed in downward trend over 1% lower than yesterday, at $141 and change. Hopefully it will go lower still tomorrow, to nudge under the $140 line before its time! Thanks for the 3TL recommendation, you certainly deserve more than zero credit for this one, whatever the outcome!

Cheers,
RockS

Derek: Las Vegas, NV

11/16/17 ‐ 10:53pm ET November 16, 2017 at 10:53pm ET

Nice! I’m rooting for you…

Derek

Jim Pearce

11/17/17 ‐ 10:35am ET November 17, 2017 at 10:35am ET

Hi Rock. I wasn’t expecting that news to immediately impact AON’s share price, but as details emerge later on it could drive it down in the months to come. As for your trade expiring today, AON traded as low as $140.09 this morning and is hovering around $140.50 so it wouldn’t take much to nudge it below $140 by today’s close. Fingers crossed!

MarkS

11/09/17 ‐ 4:22pm ET November 9, 2017 at 4:22pm ET

closed out my Nov 17 150/145 put debit spread for a 203% gain. not bad for a 14 day holding period (Oct 26-Nov 9).

thanks, Jim

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