Lockheed Martin Diagonal Call Spread (Update)

Yesterday, following several weeks of upward movement in LMT, I rolled the 15 December 75s I had sold to January, for a net credit of $1,350, less commissions. This trade raises cash, increases my downside protection after the recent rise in stock price, and and will allow for more time decay provided that LMT stays within the 75-80 range prior to expiration.

Buckle Inc. Diagonal Call Spread (Update)

Today, I added to my existing Buckle diagonal call spread by selling 5 December 2009 30s, and purchasing 6 June 30s, for a net debit of $2,300 less commissions. This week Buckle reported strong earnings while its stock price continued to drift lower - I continue to like Buckle's medium to long term potential.

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.

A-Power Energy Generations Systems, Ltd. Naked Puts

Summary: On Tuesday, I sold 10 March 2010 $10 puts on A-Power Energy Generations Systems, Ltd. (APWR), for a net credit of $1,700 less commissions. A-Power closed Tuesday afternoon at $11.39 per share. Because I have sold the puts "naked," cash collateral of $2,700 as of Tuesday's close was required (this collateral will increase or decrease depending on the underlying stock's price movement).

Rationale: A-Power's core business is building onsite power generations systems in China, but it also has a rapidly growing wind turbine design and manufacturing business. This year it has won several contracts to build turbines for various partners in China, entered into a joint venture to build turbines with General Electric, and this week announced its participation in a $1.5 billion wind farm project in west Texas. The stock is a true growth story - revenue was $152M in FY 2007, $264M in FY 2008, and analysts estimate revenue to be $324M in FY 2009 and $574M in FY 2010. Earnings have followed a similar upward path. Nevertheless, the stock trades at less than 9x projected forward earnings and less than 15x trailing earnings. The company's balance sheet is pristine with roughly $40M cash and no debt.

That being said, the stock is tremendously volatile and its future is tied to the continued demand for a rather speculative product in a developing market. By selling out of the money puts, I can target a much more conservative purchase price, in this case effectively $8.3 ($10 strike price less $1.70 in premiums), which is around 26.5% below its current price, and would be less than 10x trailing and 7x forward earnings. In the event the puts are not exercised and the puts expire worthless, I will have generated a real return of 20.4% on my reserved cash (less the option premium) over a five month period (IRR of roughly 65%). Note that because this stock is very volatile, the options hold the level of premium necessary to generate this sort of return. Because I'd be glad to purchase the stock at $8.3 per share and go long, I can use high volatility to my advantage as a value-driven investor. Note the difference between this approach and merely selling high vega to generate higher returns.

Rick's Cabaret International Puts

Summary: On 10/28, following a severe decline in the price of Rick's stock (RICK), I sold 10 December 2009 7.50 puts, for a net credit of $1,100. At the time, the puts were slightly in the money. Because these are "naked" puts, a brokerage will require cash collateral in the event of exercise, which as of 10/30 was $2,537.

Rationale: Rick's, the owner of several "adult nightclubs" (strip clubs) is a stock I follow and have long thought to be a good investment if purchased at an appropriate price. It trades at a low multiple of earnings (which as of 10/30 was roughly 7.5x predicted forward earnings) and generates strong free cash flow. Rick's is a consolidation story - it acquires clubs generally at low multiples of earnings (likely possible given the lack of buyers and general unsophistication within the industry), which are, in most cases, immediately accretive to earnings (there are exceptions - the company acquired the old Las Vegas Scores at a hefty price and which has since been a losing investment). In the event the puts are exercised, my effective purchase price would be $6.4 per share ($7.50 less the $1.10 premium). This price would value Rick's equity at less than 7x forward earnings, a multiple I believe more than prices in the past year's lackluster earnings and liquidity scare (which has since abated) and the current economic environment, and would present a favorable risk/reward scenario to go long the stock. After purchasing the stock, I will look to sell calls against my holdings so long as I can capture favorable premium at an appropriate price. If the puts are not exercised, and Rick's stock closes above $7.50 per share as of the December closing, the captured put premium would represent a roughly 17% real return on the cash required to purchase Rick stock, less the put premium, over a two month period, and obviously an even higher return on my actual reserved cash. Note that given the possibility of exercise, I do not find it appropriate to calculate return on this investment using merely a brokerage's margin requirements as the amount invested.

Buckle Inc. Diagonal Ratio Spread

Summary: On 10/23, I purchased a diagonal ratio call spread on Buckle Inc. (BKE), which consists of purchasing 6 in the money June 2010 25s, and selling 4 in the money December 2009 30s, for a net debit of $2900.

Break-Even Point: Break-even point is likely around 28 to 29, depending on the IV of the June calls at December expiration.

Max Profit: Maximum profit is theoretically unlimited because I am long two more June 25s, then I am short December 30s.

Potential Downside: Downside is limited to my net debit of $2900.

Greeks: Similar to my three other diagonal call spreads, delta and vega are substantial, and theta is positive, and will increase nearing expiration. See the portfolio screenshot for periodic updates as to this position's greek metrics.

Rationale: Buckle is a well managed, casual apparel, mall-based retailer. Buckle has been and is currently growing rapidly, but doing so in a principled manner and without the use of debt. EPS has grown from .86 in 2005 to 2.24 in 2009. Throughout this period, Buckle has generated substantial cash and has been a net buyer of its stock. Its five-year average revenue growth rate is 13.4%, while its five-year average EPS growth rate is 26.4%, a result of both share repurchases and margin expansion. Buckle generates terrific and peer-beating returns on assets and equity (without the use of debt). Nevertheless, the market is currently valuing Buckle's equity at historically low multiples of earnings due to the tough retail market - it's trading at around 6x EV/trailing EBITDA or 12x trailing earnings. Given management's track record and the current valuation, I am bullish on Buckle's near-term, and even more so, its long-term prospects, but appreciate the potential challenges both to its stock price and its business. This position provides some near-term downside protection and profits from time decay, while preserving upside. In the event Buckle's stock slides substantially in the near-term, I will look to gain further upside exposure.

Note that Buckle reports earnings November 17th, which will likely cause a substantial move in the stock price.