Market Overview
Before we dive into this week’s covered call idea I wanted to do a bit of housekeeping. Because the stock market is closed for the Fourth of July next Tuesday, you will receive the next issue of Cabot Profit Booster on Wednesday, July 5. Have a great Fourth!
Moving on …
The market’s steady advance came to a halt last week, though given the recent run higher, the losses felt “normal.” For the week the S&P 500 fell 1.4%, the Dow lost 1.67%, and the Nasdaq declined by 1.45%.
This week we are adding a somewhat high-flying growth stock that has pulled back normally after a recent move higher, much like the market. Though just in case the market is ready to pull in further, I am again going to play this stock somewhat defensively by selling an in-the-money call.
The Stock – Confluent (CFLT)
Why the Strength
Every cycle usually has a couple of leading “tech infrastructure” plays, with new leaders in chips and networking often appearing every couple of years. Big Data, though, has been an outlier, with few storage stocks really joining the ranks of leadership. But we think Confluent could change that.
The firm’s platform is the best at helping programmers use Apache Kafka, which is an open-source data processing software used by over 100,000 firms (and most big companies); in fact, the founders of Confluent created Kafka while at LinkedIn years ago. The details can be in the weeds, but the big idea here is that the firm’s offerings allow for a real-time data “streaming” operation that can be integrated with all of a client’s technology, so everyone can get real-time insights, updates and action items. (In Confluent’s words, its platform is becoming the central nervous system of a firm’s tech stack, with everything else connected to it and dependent on it.)
The company does have an on-premise offering that’s still growing (up 16% in Q1), but the bigger opportunity is the cloud, which makes up 42% of revenues but expanded 89% last quarter—management made a point in the latest conference call by saying that it’s developed better and cheaper ways to deliver that cloud service, which is a big competitive advantage.
To be fair, growth is slowing somewhat here (mostly due to economic factors) and the bottom line is still in the red, but the opportunity is enormous (the top brass puts it at $60 billion) and operating income is expected to reach breakeven by year-end. Top-line growth of 30%-plus seems likely for a long time to come.
Technical Analysis
CFLT crashed from a post-IPO high of 95 in 2021 to a low of 16.5 last spring and spent forever building a big bottoming pattern; in early May, the stock was still sitting at 20. But then everything changed, with a powerful six-week advance that brought shares to 14-month highs. Now we see CFLT losing some altitude with the market—a pullback that has seen some volume selling and could go further, but overall seems well controlled compared to the prior advance. Stop — 27.5
The Covered Call Trade
Buy Confluent (CFLT) Stock at 33, Sell to Open August 32 Strike Calls (exp. 8/18) for $3.70, or a Net Price of 29.3 or less
Static Return: $270 per covered call (9.21%)
Breakeven: 29.3
Covered Call Return (if assigned): $270 per covered call (9.21%)
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 29.3 or less. (In this case 33 minus 3.70 = 29.3. Or another example is you could pay 33.20 for the stock and sell the call for 3.90, which also equals 29.3)
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 July 5, 2023.
