Goldman Sachs Adds Williams (NYSE:WMB) to “Conviction Buy” List

Williams Companies WMB was given a solid vote of confidence on Friday, as Goldman Sachs upped its rating on the natural gas company to “conviction buy” from “buy.” The brokerage said it was placing WMB on its conviction buy list “with 35% total upside to our $28, 12-month target price. An investment in WMB,” Goldman noted, “provides a superior ‘Growth & Income’ vehicle for today’s uncertain market … valuation is compelling, trading at a [five times] 2010 EBITDA multiple versus peers at 8x and its two-year average of 7x.”

WMB moved slightly higher on the day while the broader market hovered near the breakeven zone. Since May 25, WMB shares have retraced 18% of their downside; the stock lost a quarter of its value between its late-April peak and its late-May valley. Is the selling pressure over for WMB shares? Does Goldman Sachs have the courage of its “conviction?”

While traditional brokers are confined to variations of “buy,” “hold,” and “sell,” traders in the options market have many tools at their disposal. Option strategies can be fine-tuned depending on an investor’s level of optimism (or pessimism) and can be impacted by forces other than just the stock itself (including time and changes in volatility).

*Prices given as of Friday afternoon. WMB was trading at $21.36.

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Bullish Option Strategy: Long LEAPS Call

Do you agree, as Goldman does, that WMB has up to 35% of upside in the next 12 months? A near-the-money LEAPS call (with 18 months until expiration) might be an intriguing play if the gains in the shares come to fruition. The near-the-money January 2012 22.50 call is currently priced at $3.30 (and the maximum a call buyer can lose is 100% of the premium paid). If the stock begins to rally, gains are theoretically unlimited. Breakeven at expiration in January 2012 is $25.80, or the strike price plus the premium.

Profit/Loss of WMB long call

Moderately Bearish Option Strategy: Bear Call Spread

The 25 level has been a tricky one for WMB in recent months. The stock hasn’t traded above this level since September 2008 and it is currently the site of Williams’ 40-month moving average. This trendline rejected the stock’s upside attempts in April and May. Moderately bearish investors who don’t think WMB will be able to topple this area over the next several months could sell an upside call spread. The November 25/27 call spread can be sold for a net credit of 34 cents, which the investor keeps as profit if the stock is still below this level when the options expire. Maximum losses are capped at $1.66, for a return on risk of 20.5%.

Breakeven for this spread is $25.34; if WMB is trading below this level when the options expire, the spread will be profitable. Because this trade allows for more than 18% of upside before it enters losing territory, this particular spread is just moderately bearish in nature (as opposed to a strategy like a long put that anticipates actual downside). Also note that probability typically has an inverse relationship to profitability; the more likely a trade is to close in the money, the smaller the potential reward may be.