True Religion Apparel, Inc. Puts

Summary: Today I sold four True Religion Apparel, Inc. (Ticker Symbol: TRLG) July 2010 25 puts for a credit of $3,080.00, less commissions. Because the puts were sold "naked," my brokerage has reserved $4,602.40 of cash in my account. The net result of the transaction is a decline in my purchasing power of $1522.40.

Break-Even Point: Break-Even point on the transaction is around $17.3 per share, or about 5.5% downside protection from the stock's price at the time of sale.

Max Profit: Maximum profit is the credit of $3,080.00, less commissions, which will be achieved if the stock is at or above $25 per share at expiration.

Potential Downside: My maximum potential loss on the position is $6920.00, plus commissions, which will occur if the stock goes to $0.

Greeks: Given that these are deep in-the-money puts, the position's delta shows what is roughly a 1 to 1 ratio with the stock's price. Theta is moderately positive because of the roughly $1.00 in extrinsic value and will increase closer to expiration or with a rise in the stock (due to an increase in extrinsic value).

Rationale: Following a recent quarterly earnings miss, True Religion (a high-end jean manufacturer and retailer) has seen its stock price decline substantially to a six-month low, and is now trading at a very compelling multiple of trailing and forward earnings - about 9.6x and 8.6x respectively, less on an enterprise value basis (due to a net cash position of roughly $80M). The company has exhibited tremendous growth during its short existence, has built a great brand (albeit an expensive one) and has a loyal following which has largely continued purchasing the company's products during this long recession. While there is certainly an abundance of competition in the high-end denim market and the continued recession will no doubt dampen TRLG's earnings, I believe the company's current valuation offers a compelling risk-reward ratio over the coming years. To capture a significant amount of this upside, while providing a moderate amount of downside protection, I've sold the July 25 puts. In the event the stock continues to decline and the puts are eventually exercised, I will have purchased the stock at an even more compelling valuation (assuming no serious and permanent decline in the company's business). In the event the stock rises, I will look to exit the position after a significant decline in extrinsic value.