September 21, 2021

Last week the major indices took another small step backwards. The S&P 500 lost 0.57%, the Dow fell 0.06%, and the Nasdaq declined 0.41%.

The decline deepened among all the major indices Monday as ongoing uncertainties around Chinese property developer Evergrande heightened. Evergrande faces a debt payment on its offshore bonds Thursday, so until some clarity is seen I would expect to see further volatility.

The S&P 500 has now witnessed a 4.4% decline since the closing highs back on September 2. So the 5% pullback everyone has been discussing over the past several weeks could come to fruition over the next few trading sessions.

To be more defensive, this week I am going to sell in-the-money calls to stay a bit on the safe side.

Cabot Profit Booster 193

Before we dive into this week’s idea, I wanted to do a bit of “house cleaning.”

Last week we closed three covered calls for full profits. Here are the details:
DT – A profit of $350 per covered call, or a yield of 5.7%
ON – A profit of $280 per covered call, or a yield of 6.48%
BLDR – A profit of $160 per covered call, or a yield of 3.3%

The one trade from the September expiration cycle that was not closed last week was CFX, which leaves us with the stock and no option position. While it is possible that CFX will rebound in the days/weeks to come, because of the market weakness, I am going to sell my stock position today and take my small loss. If you would prefer to sell a new call, which I am not doing, I might target the October 45 strike to further lower your cost basis.

One more note: TX, along with all steel stocks, got hit hard the last two trading days, and fell through our stop yesterday. Will this be short-term weakness, or the start of a more meaningful decline for the stock? It’s truly anyone’s guess.

I am going to give TX a bit more time to see if the stock can rebound, though I may roll our short call to a strike that is closer to the current stock price in the days to come. You will be hearing from me regarding how I will manage TX depending on the stock, and market conditions.

Moving on to the market, and this week’s idea …

Last week the major indices took another small step backwards. The S&P 500 lost 0.57%, the Dow fell 0.06%, and the Nasdaq declined 0.41%.

The decline deepened among all the major indices Monday as ongoing uncertainties around Chinese property developer Evergrande heightened. Evergrande faces a debt payment on its offshore bonds Thursday, so until some clarity is seen I would expect to see further volatility.

The S&P 500 has now witnessed a 4.4% decline since the closing highs back on September 2. So the 5% pullback everyone has been discussing over the past several weeks could come to fruition over the next few trading sessions.

To be more defensive, this week I am going to sell in-the-money calls to stay a bit on the safe side.

This week’s pick is American web infrastructure and website security company Cloudflare (NET).

The Stock – Cloudflare (NET)
Why the Strength

Nobody is going to argue that Cloudflare (or any stock for that matter) is the next Cisco Systems, which was one of the stock market’s biggest winners of all time.

But in terms of fundamental positioning, we see a lot of similarities here—back in the day, Cisco had the right products to help interconnect people and companies just as the internet was hitting the mainstream, while today, Cloudflare has the “new” kind of network that helps firms (from small to giant) speed up (supposedly websites load twice as fast and use 60% less bandwidth) and protect their websites, content delivery, apps and teams, while being the best platform for app development.

Effectively, then, Cloudflare is providing the core infrastructure to the cloud- and app-based world, with a network that spans 250 cities worldwide in more than 100 countries, interconnects to 9,800 other networks directly and is just 50 milliseconds from 95% of the world’s internet-connected population.

Many can use the offering for free (to, say, protect and accelerate a couple of small websites), but the company is continually coming out with new products that are enticing more and more customers (126,000 paying in total) and big users to pay; at the end of Q2, 19% of the Fortune 1,000 are paying customers (and they’re buying more—same-customer revenue growth was 25% in the quarter). We see no reason that figure can’t double or triple in the years ahead.

Revenue growth has been both rapid and reliable in the 50% range for many quarters, and while earnings are slightly in the red, that’s because management is focused on investing to capture what it believes will be a $100 billion opportunity within a few years. It’s a big idea.

Technical Analysis
NET has had a big run over the past year, so it’s not in the first inning of its overall advance. Still, we see solid upside if growth stocks hold together—shares effectively took nearly six months to rest (December-May), and after tagging their 40-week line, have embarked on an excellent run, with just three down weeks since then.

Lately, progress has been tougher, but NET bounced off its 10-week line last week and held its 25-day line on today’s dump. Stop — 108

The Covered Call Trade
Buy Cloudflare (NET) Stock at 129.50, Sell to Open October 126 Strike Calls (exp. 10/15) for $7.50, or a Net Price of 122 or less

Static Return: $400 per covered call (3.28%)

Breakeven: 122.00

Covered Call Return (if assigned): $400 per covered call (3.28%)

Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.

However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 122 or less. (In this case 129.50 minus 7.50 = 122. Or another example is you could pay 128 for the stock and sell the call for 6.00, which also equals 122.)

For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …

Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.

The next Cabot Profit Booster issue will be published on September 28, 2021.
Cabot Wealth Network
Publishing independent investment advice since 1970.

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Chief Investment Strategist: Timothy Lutts
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