After a big run higher for the market to end 2023, 2024 got off to a rough start yesterday, especially for growth stocks. And while yesterday was sloppy, this action isn’t terribly surprising as crosscurrents in the new year are typical.
This week we are adding a covered call in a leading retailer, though because of the choppy January trading, we are doing so via an in-the-money call sale.
The Stock – Gap (GPS)
Why the Strength
U.S. holiday sales from both in-store and online channels grew 3% between November 1 and December 24, according to data released by Mastercard, with apparel sales rising over 2% from a year ago. However, this was below last year’s 8% rise as consumers continue to feel the sting of inflation and higher interest rates.
The challenging retail environment has pressured big-name apparel retailer Gap (covered in the November 20 issue), which saw its third-quarter revenue decline 7%, led by an 11% sales loss for its Banana Republic business and an 18% sales drop for its Athleta segment. But investors see a turnaround ahead.
The company has been aggressive in its efforts to revive sales, including tightening inventories and increasing its digital footprint (online sales now account for 32% of total revenue, making Gap less reliant on out-of-favor shopping malls), and management recently stated its intent to “re-set the company for long-term success” with additional initiatives, including improving product assortments, balancing essentials with new trends and adjusting pricing strategy to reflect “jaw-dropping value” to customers.
Moreover, the top brass thinks it can grow its Old Navy brand (the number two apparel brand in the U.S.) by more than 700 stores in North America (from around 1,200 today) in the coming years. To that end, analysts forecast Old Navy to be a sales leader going forward as it introduces trendier clothing to its lineup.
Meanwhile, Gap is also working to re-position Banana Republic with an increased focus on aesthetics, fabrication and quality; it sees an opportunity for the line to “thrive in the quiet luxury space,” with its cashmere and leather product offerings already “translating well.”
Most importantly, after a rough 2022, earnings are crushing estimates (59 cents in Q3 vs. 19 cents expected) and Wall Street sees the bottom line doubling within a few years even after the recent rebound.
Technical Analysis
We missed getting into GPS in November as the stock never pulled back into our buy range after its earnings-induced pop. The stock rallied an additional four points after that, but it finally hit some resistance near 22—though, since then, it’s basically just marked time while the 25-day line has caught up. A deeper retreat is always possible, but the evidence tells us the buyers are certainly in control. Stop — 17.5
The Covered Call Trade
Buy Gap (GPS) Stock at 20.5, Sell to Open February 20 Strike Calls (exp. 2/16) for $1.40, or a Net Price of 19.10 or less
Static Return: $90 per covered call (4.71%)
Breakeven: 19.10
Covered Call Return (if assigned): $90 per covered call (4.71%)
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 19.10 or less. (In this case 20.5 minus 1.40 = 19.10. Or another example is you could pay 20.35 for the stock and sell the call for 1.25, which also equals 19.10)
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 January 9, 2024.
