Two more Bull Call Spreads.
music selection: “Louder Than Hell” — Motley Crue
weigh-in: 208.8 n/c
I am concerned with the length of the bull market and the Bull In A China Shop of a President America has. The trade war with China makes no sense. POTUS has recently tweeted that the increase in tariffs are a win for America. If it were so easy to “win” by implementing tariffs, why doesn’t Alabama for example put tariffs on goods from California? Heck, let’s pick each individual county within a state against each other. Surely, the GDP of each county would rise proportionally to the tariffs, right? Today’s trade action have the markets down about 2% as of this writing. Someone needs to delete POTUS’s Twitter account. As a result, I’m getting more defensive.
Today, I have two new Bull Call Spread trades that are well in the money for additional protection. I am limiting my downside to half of 1,200 for each trade. My typical covered call trades on 10,000 capital at risk and 25% trailing stop loss carries 2,500 downside versus today’s 600. You’ll see the returns are just fine and the delta as reported by CBOE probability of maximum return on the trades over 80%. The probability of a complete loss is under 5% in each trade.
First is HD Supply (HDS). This is a specialty building products distributor that is best in class and the market share leader in a very fragmented industry. It’s share price is greatly depressed because it somewhat recently went public after being a private equity victim. The PE firm loaded the firm up with debt to cash out. In recent years, the company has shown remarkable capital discipline and has paid down billions in debt. It is now opportunistically buying back shares. Management has shown great discipline to only buy shares on pull backs and is creating a lot of value. The company has great free cash flow and a long runway to roll up a fragmented industry for remarkable growth.
With shares trading at 42.41, I elected to buy the 35/37.5 bull call spread with 20SEP2019 expiry. I got in for a net debit of 2.1333 per share. The maximum return of 17.19% (47.89% annualized) will be earned even if shares fall as much as 11.57% between now and expiry. The trade will be in force for 131 days. I’ll exit early if the spread price closes a day below 1.07 (50% decline). Otherwise, I intend to hold to maturity unless shares rally and the majority of the gains can be booked early.
Next is Hershey (HSY). HSY is a great company at a great price if you are looking for a long term buy and hold investment. It is a real sleep at night stock. Lots of investors will look the other way because sales are only growing a few percent a year. But with its enormous level of capital efficiency, the company can return 15% or more per year for many decades at that level of growth. Dividend cost exceeds capital expenditures, which is rare. And the company is a relentless raiser of its distribution. Add in a solid moat from one of the world’s most valued brands, and you have a rock solid stock.
I’m making a shorter term play however (if I had capital to deploy in my tIRA, I’d look strongly at HSY buy/hold). With shares trading at 126.76, I bought the 115/120 bull call spread with 16AUG2019 expiry. I paid 4.00 per share. The trade will be in force for 96 days and earns the maximum return of 25% (126.74% annualized) even if shares fall 4.76% by expiration. The stock would have to fall 8.73% for the spread to expire worthless. That would be a catastrophic drop for a slow moving, stable, blue chip, dividend raiser. I’ll exit early if the spread closes a day below 2.00 or if most of the 5.00 spread can be earned with a lot of time left.
Devour your prey raptors!