Next week is one of Cabot Top Ten Trader’s two weeks off for the year. This means there won’t be a new Cabot Profit Booster idea next week. Have a fantastic Thanksgiving!
Before we dive into this week’s idea, we need to address our two trades that did not expire for full profits on Friday.
First off, we are going to continue to sell calls against our RRC stock position.
To execute this trade you need to:
Sell to Open the RRC December 34 call for $0.60 approximately.
Next up, we are going to sell our PR stock position, as the call premiums are not large enough to be worthwhile to keep this trade.
To execute this trade you need to:
Sell your PR stock position.
Moving on …
The bulls succeeding in pushing the market higher again last week as the S&P 500 gained 2.6%, the Dow rose by 2% and the Nasdaq rallied 2.45%. This week should be slow/quiet, though when there is a lack of liquidity in the market, you never know …
The Stock – Gap (GPS)
Why the Strength
Despite overall declines in the U.S. apparel market, Gap is turning heads after gaining market share in what has been a challenging retail environment. The company’s progress was highlighted in last week’s Q3 earnings report that gave shares their best single-day performance in over three years.
Although revenue of $3.8 billion was 7% lower from a year ago, it exceeded estimates, while earnings of 59 cents a share beat the consensus by a whopping 39 cents. By segment, Gap brand sales were 15% lower at $887 million, but those sales would have declined just 6% if not for the sale of Gap China and the discontinuation of the Yeezy Gap partnership.
The company’s Banana Republic business posted an 11% sales loss, while the Athleta segment saw sales fall 18%, in part due to comparisons with last year’s elevated discount levels. However, Gap has big plans for Athleta going forward, including several new store openings, and believes the brand has “significant growth potential” after reaching the number-five spot for top selling U.S. women’s active wear. As for Banana Republic, management is working to re-position it as a premium lifestyle brand while acquiring new, high-value customers.
Encouragingly, both the Old Navy (the number two U.S. apparel brand) and Gap chains increased market share in Q3, driven by strength in the women’s, kids, and baby categories, and more importantly margins expanded, inventories tightened and the top brass was optimistic on both headed into the holiday shopping season. (Analysts further expect Old Navy to be a sales leader going forward as it introduces trendier clothing to its lineup.)
Cash flow here is strong and the valuation looks reasonable; Wall Street sees earnings up single digits next year, but given some recent beats, most think that could prove way too conservative.
GPS peaked in May 2021 around 35 and then sank like a stone, declining almost non-stop for the next 14 months; it spent months bottoming in the 7 to 8 area before finally turning the corner in May. The initial recovery wasn’t anything to write home about, but GPS started to act great in early October and then catapulted on massive volume last Friday, reaching its highest level since January 2022. Stop — 14
The Covered Call Trade
Buy Gap (GPS) Stock at 18.50, Sell to Open December 18.5 Strike Calls (exp. 12/15) for $0.60, or a Net Price of 17.90 or less
Static Return: $60 per covered call (3.35%)
Covered Call Return (if assigned): $60 per covered call (3.35%)
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 17.9 or less. (In this case 18.5 minus 0.60 = 17.90. Or another example is you could pay 18.3 for the stock and sell the call for 0.40, which also equals 17.90)
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 …
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 December 5, 2023.