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Tuesday, January 27, 2009

Establish Home Depot Inc Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Home Depot Inc (HD) covered calls.

This position definitely qualifies as a contrarian investment. Today, the Conference Board reported that their monthly U.S. Consumer Confidence Index declined to 37.7, the lowest level ever in the 42 years they have been tracking this indicator. So why invest in a U.S. consumer discretionary company in the face of this horrendous backdrop?

First, Home Depot and Lowe's have developed, for all practical purposes, into a North American duopoly in the retail home improvement market. Home Depot is a well-managed company and is performing reasonably well so far during this severe recession. During the first half of 2009, they will be a direct beneficiary and recipient of a portion of the extra dollars that will be available to consumers from the substantially lower gasoline prices compared with the comparable period in 2008. Also, people are spending less on their nice-to-haves (such as an expensive vacation) and more on the items they consider more essential (such as maintaining their homes). There are also strong indications that both the Obama stimulus package and the remaining TARP spending will be highly targeted to attempt to directly benefit consumers. These positive factors will take months to manifest themselves as tangible benefits to consumers, but consumer confidence could likely soon begin to become somewhat more positive.

Home Depot used to be considered as a growth stock. But its stock price has now declined to the point where it is now a compelling value-oriented investment. For example, its price-to-book value, price-to-cash flow, price-to-earnings, and price-to-sales metrics are at or near historic lows. HD could very well prove to be a very attractive long-term investment if purchased now at its current price.

A summary of the transactions is as follows:

Established Home Depot Inc Covered Calls for Feb09:
01/27/09 Bought 300 HD @ $21.95
01/27/09 Sold 3 HD Feb09 $22.50 Calls @ $.89

Absolute Return if Unchanged: +4.1%
Annualized Return If Unchanged (ARIU): +59.1%
Absolute Return if Exercised: +6.6%
Annualized Return If Exercised (ARIE): +95.8%
Downside Breakeven Price Point: $21.06
Downside Breakeven Protection: 4.1%

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