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Michael Fowlkes' Analyst Insights

InvestorsObserver
Options and ETF Analyst Writer
Michael Fowlkes
Author Bio


March 2, 2015 - Genuine Parts to Benefit From the Wintry Weather

Over the last few weeks, a large portion of the U.S. has found itself dealing with multiple winter storms. Warm weather will start to melt most of the ice and snow, however the aftermath of the storms will linger. Torn up streets, flooded homes and cars towed from accidents will all take time to repair.

While no one wants to see others suffer, it would not be prudent to ignore the investment opportunity that this damage creates. One company that really stands to benefit from the winter storms is Genuine Parts Co. (GPC).  This is a company that sells auto parts that are required to repair the cars that were damaged due to the winter storms.

Even before the vehicular accidents were caused by the winter storms, GPC was an attractive stock. The auto industry continues to improve and people are always willing to buy new cars, or if not purchase new, spend money to fix up and upgrade their current vehicles.

Low gas prices create a good growth environment for the company.  As low gas prices lead to more miles being driven in cars and those extra miles will result in more replacement parts needed. GPC stock has been in a sideways trend for the last month, but with a P/E of just over 20 and analysts expecting earnings growth of 8% next year, there is potential upside for the stock.

Anticipating future upside to GPC shares, an investor could simply jump in and buy some shares of the stock. A better approach, however, may be to set up a covered call. Covered calls are attractive because they allow you the possibility of pulling in a nice return even if the stock stays flat, and lowers the cost an investor pays for each share of stock purchased.

To get a better understanding on how covered calls work, let's look at a sample trade on GPC using real time numbers.

Charts courtesy of www.stockcharts.com

To set up the trade, the investor would buy GPC stock for $96.25 per share (100 shares or scale as appropriate) while selling one contract (100 shares worth) of the GPC May 100 call for no less than $1.35 per share. The break even on the trade becomes the cost of your stock minus the proceeds from the sold call. This results in a breakeven of $94.90. The result of the transaction is that the investor now controls 100 shares of stock. Rather than paying the current market price for the shares, the investor was able to lower the cost to $94.40 per share.

If GPC is trading above $100 on May 15 when the call expires, the market will exercise the option to buy the stock at $100. Profit would be the $100 sell price, less the cost of $94.40, so the profit would be $5.60 per share. Since the investor paid $94.40, the return on the investment is 6.0%. With the position open for 77 days, the annualized return on the trade becomes 28.4% (for comparison purposes only).

The other possibility is that GPC is trading below $100 at May expiration. Should this occur, the option will expire worthless, and the investor will be left holding the stock in their portfolio. The good news is that the investor can still make a profit as long as shares are above $94.40 by simply selling the stock. The investor could also sell another call which would lower the cost basis on the shares even more. As you can see, there really is no bad outcome to the trade.

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