Before we dive into this week’s covered call idea, we need to address three positions from the October expiration cycle.
First off, because the market is weak, we are going to exit our Yeti (YETI) stock position as this stock looks suspect along with the market.
To execute this trade you need to:
Sell your YETI Stock
Next up is PBF Energy (PBF) and Dell (DELL), which we are going to continue to sell calls against in order lower our cost basis as the stocks look fairly solid despite the market’s weakness.
To execute this trade you need to:
Sell to Open the PBF November 50 call (exp. 11/17) for $1.75 (approximately).
Sell to Open the DELL November 68 call (exp. 11/17) for $1.25 (approximately).
Moving on …
The historic move in the bond market continued to weigh on stocks last week as the S&P 500 lost 2.4%, the Dow fell 1.6% and the Nasdaq declined by 3.1%. With a busy week of earnings ahead, here’s hoping for better results this week.
This week traders will start to dial in on earnings season which ramps up in a big way with many of the tech titans (MSFT, GOOG, META, AMZN, etc.) reporting quarterly results.
The Stock – American Eagle Outfitters (AEO)
Why the Strength
In what can only be described as a challenging environment for U.S. clothing retailers—characterized by a rash of smash-and-grab thefts in retail stores nationwide—American Eagle has managed to maintain growth while boosting profit margins as consumers gravitate toward higher-end apparel offerings. The company offers on-trend clothing, accessories and personal care products under the American Eagle (specializing in denimwear) and Aerie (lingerie and activewear) brands through nearly 900 store locations worldwide.
The firm’s latest quarterly report in early September had more than a few encouraging nuggets. Although total Q2 revenue of $1.2 billion was essentially flat from a year ago, it improved 11% from the prior quarter and set an all-time high for the second quarter, with store revenue rising 4%. American Eagle said it’s seeing “positive momentum” and an ongoing sequential revenue improvement trend supported by several new marketing campaigns and on-trend collections that are “resonating well” with customers. By segment, Aerie sales of $380 million increased 2% while American Eagle sales of $767 million were up 1%.
The main reason for the strength, however, isn’t an out-and-out growth story but a return to normalcy when it comes to earnings, thanks to cost controls, inventory management and a normalization of supply chain shenanigans from the past few years—despite so-so revenue tallies, per-share earnings of 25 cents in Q2 improved an eye-opening 21 cents from a year ago while beating estimates by 60%. The company touted its continued focus on maintaining inventory discipline, posting a 7% total inventory decline with units down 11%, and management said the profit improvement focus is expected to yield even more positive results over the next 12 to 24 months.
Looking ahead, expect modest sales improvement and, while 2024 earnings estimates are mundane, many are likely looking for more bottom-line beats, which makes the already-modest valuation even more appealing.
AEO topped out in June 2021 and slid almost continuously until last October, surrendering about 75% along the way. There was a solid rally after that, but shares petered out in February and ended up retesting the low near 10 in May. Since then, though, it’s been all good—AEO shot back to slightly higher highs in September, and perhaps more encouragingly, its dip that month led to a strong bounce to higher highs despite the market. Stop – 15.2
The Covered Call Trade
Buy American Eagle Outfitters (AEO) Stock at 17.50, Sell to Open November 17.5 Strike Calls (exp. 11/17) for $0.70, or a Net Price of 16.8 or less
Static Return: $70 per covered call (4.16%)
Covered Call Return (if assigned): $70 per covered call (4.16%)
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 16.8 or less. (In this case 17.5 minus 0.70 = 16.8. Or another example is you could pay 17.60 for the stock and sell the call for 0.80, which also equals 16.8)
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 October 31, 2023.