Wednesday, November 25, 2009

Establish Aeropostale Inc. Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Aeropostale Inc. (ARO) covered calls as follows:

Established Aeropostale Inc. (ARO) Covered Calls for Dec09:
11/25/09 Bought 300 ARO @ $30.56
11/25/09 Sold 3 ARO Dec09 $31.00 Calls @ $1.30

Aeropostale, Inc. operates as a mall-based specialty retailer offering proprietary branded, value-priced, active-oriented casual apparel and accessories. Their market is primarily teens between 14 and 17 years old. The company offers a collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, and outerwear; and various accessories including sunglasses, belts, socks, and hats under AEROPOSTALE, AERO, 87, and other related trademarks. It has a very strong competitor in Gap Inc. and to a lesser extent the higher-end teen mall retailers of American Eagle Outfitters and Abercrombie & Fitch. Nevertheless, Standard & Poor's calls Aeropostale "the best performing teen apparel retailer in the mall." Aeropostale operates a total of over 900 stores located almost exclusively in the U.S.

Aeropostale provides both good growth and value characteristics; this year it is continuing its perennial store-for-store sales growth and this has afforded management the opportunity to be selectively less aggressive with promotional markdowns. As a result, merchandise gross margins are likely to increase this year by more than 3.0 percentage points. This, in combination with management's continuing excellent expense controls are resulting in outstanding profitability (measured by return on invested capital) results. Yet at its current price, it is also a compelling value investment since its P/E ratio is below 10.0 based on its expected current year earnings of $3.20 per share. Third quarter earnings will be announced on Dec 2nd, but these results are well known since the company has already announced its sales results and has a tight window of $.90-$.91 for quarterly earnings. The more important announcement that day will be ARO's November sales results; this advisor believes this could be a positive catalyst for the stock price since this year will be compared with the relatively depressed sales levels during last year's credit crisis.

The 'Buy Alerts' spreadsheet below shows that ARO has a 'Total Points' rating of 21.49 which exceeds the Covered Calls Advisor's desired threshold of 20.0 points.

Note: For expanded view, left click on the spreadsheet above.

Some possible overall performance results(including commissions) for the ARO transactions would be as follows:
Stock Purchase Cost: $9,176.95
= ($30.56*300+$8.95 commission)

Net Profit:
(a) Options Income: +$378.80
= (300*$1.30 - $11.20 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If stock price unchanged at $30.56):
-$8.95 = ($30.56-$30.56)*300 - $8.95 commissions
(c) Capital Appreciation (If exercised at $31.00): +$123.05
= ($31.00-$30.56)*300 - $8.95 commissions

Total Net Profit(If stock price unchanged at $30.56): +$369.85
= (+$378.80 +$0.00 -$8.95)
Total Net Profit(If stock price exercised at $31.00): +$501.85
= (+$378.80 +$0.00 +$123.05)

Absolute Return if Unchanged at $30.56: +4.1%
= +$369.85/$9,176.95
Annualized Return If Unchanged (ARIU) +62.8%
= (+$132.85/$9,176.95)*(365/24 days)

Absolute Return if Exercised at $46.00: +5.5%
= +$501.85/$9,176.95
Annualized Return If Exercised (ARIE) +83.2%
= (+$144.85/$9,176.95)*(365/24 days)


  1. Jeff,

    ARO will post earnings on 12/2. Do you normally sell calls when this will happen? I did not follow the general rule against this and got burned badly by TQNT and CSTR last month.

  2. If you are a member of the "justcoveredcalls" Yahoo Group, then I'd recommend you reference the message thread from Oct.25th,2009 titled "Avoiding Earnings Reports?". Here is a post I made there that summarizes my current basic viewpoint as related to your question:
    "I agree completely with your perspective on how we should view earnings reports. I used to have the same perspective on this as Ellman does, but I now believe
    (as Howard does) that viewpoint is too restrictive to have a policy of always avoiding holding a covered calls position for a period that includes an earnings
    report. Once every 3 months we are in a position where over a 3-week period, the overwhelming majority of S&P 500 companies are reporting their earnings. We happen to be in the midst of that situation now.

    But I believe we can actually use the information we hear from companies reporting their earnings that we don't own (but are in the same industry as companies we do own) to benefit us in our decisions about the companies we do
    hold. For example, I currently own a reinsurance company AHL that has a substantial business exposure to catastrophe insurance. I have learned from reading just recently released earnings reports from PTP, Travelers, and Chubb
    that their recently reported earnings outperformance was enhanced because of lower than expected catastrophe losses. I'm expecting AHL to also report that
    they have benefited from this situation when they report their earnings this Thursday. So I decided to maintain my covered calls position with AHL because I
    believe it is likely they will also beat analysts' earnings expectations (just as PTP,TRV,and CB did).

    Another factor to realize about companies with impending earnings is that their options include higher options premiums than they otherwise would because of the
    uncertainty related to the possibility of an earnings surprise. You can see the extent that this is true -- simply look at the implied volatility of a
    particular option you are short a day or two prior to that company's earnings announcement and compare it with that option's IV soon after the earnings have been announced. You'll notice a substantial IV compression -- that's profits for we who sell options! So as covered calls investors who try to sell overpriced call options, we are poised to benefit from selling calls if we are correct when we anticipate a positive earnings report for a particular company."

    As far as ARO specifically is concerned, they have already pre-released their actual sales results for the prior 3 months and have narrowed their earnings guidance to either $.90 or $.91. So in this particular instance, most of the key information has already been released, so the normal earnings report uncertainty is really not present in this instance.

    Sorry for the long reply, but I hope these comments are helpful and aid you in your thinking through this worthwhile topic.