American Apparel Inc. Naked Puts

Summary: On 11/11, I sold 40 February 2010 $2.50 puts on American Apparel Inc. (APP), at $.40 each, for a net credit of $1,600 less commissions. APP closed at 2.58, and has since risen substantially to above $3.00. The puts are worth about $.25 each today.

Rationale: The controversial American Apparel's stock price has drifted aimlessly for the last several months following a liquidity and potential bankruptcy scare earlier in the year. The company is a unique participant in the retail marketplace with a loyal following and a growing international market. However, management has struggled to convert revenue growth into bottom line growth, and has dealt with several legal issues, and the current price reflects the market's well-deserved apprehension about the company's long term viability. Because of this apprehension and the stock's volatility, the February $2.50 puts offered substantial premium on 11/11. If exercised, my effective purchase price would be $2.10 per share, less commissions, which is 18% below the 11/11 closing price, and roughly 31% below today's price. At $2.10, I believe the stock's upside more than compensates for risk incurred. In the event the puts are not exercised, I will have generated a real return of roughly 19% on the amount in cash required to exercise the puts (not the amount of my margin requirement) over about a 4 month period.