Julian Close's Insights
June 29, 2015 - CALM at the Center of the Storm
Here's one of the secrets of the universe: when there isn't enough of a thing, its price goes up. Don't tell the children, but scarcity has made more people wealthy than hard work and stick-to-it-iveness combined. This very principle is responsible for the opportunity we see today in Cal-Maine Foods. Back in April, Cal-Maine was already an egg industry leader, but still not particularly exciting. As the producer of the brand Eggland's Best, the company may be best known as a long-time sponsor of Wheel of Fortune.
But then a not at all funny thing happened: avian flu wiped out 33 million American hens, and caused the government to shut down or limit egg production from hard-hit areas.
Cal-Maine Foods somehow managed to walk between the raindrops that soaked everyone else. Scarcity caused the wholesale price of eggs to rise by 42.9%, according to a June 12 report from the Department of Labor. Cal-Maine suddenly began raking in money like never before, and the stock shot from less than $40 on April 1 to more than $58 at its peak on May 18th. Since then, CALM has retrenched somewhat, and while the company's prospects look good, many people are asking whether they can risk buying now, since profit taking could push CALM stock down.
So I'm making a bet that CALM will do well for the rest of the year, while placing a short term hedge against price erosion, since the risk of that is highest in the next couple of months.
Let's look at the numbers. To make this trade, buy CALM stock for $53.79 per share (100 shares, or scale as appropriate). At the same time, sell one contract (100 shares worth) of the CALM Nov 65 call for not less than $2.10 per share, and also buy one contract (100 shares worth) of the Aug 50 put for $2.10. You will note that the premiums on your options cancel each other out, so you are left with - mostly - a covered call that expires in November, the only difference being that you have foregone the usual money from premium in exchange for the surety that if the stock falls rapidly between now and Aug 21, you'll still be able to sell it at $50. Should that happen, by the way, and you choose to exercise your put, you will lose 7.1% on the trade. There may also be an even greater risk that the stock could fall further than that after Aug 21 when your safety net is no longer in place.
If CALM above $65 on Nov 20, it will be assigned, and since your break-even price is the same as your buy price, the return can be determined even more easily than usual. Your profit in the deal would be $1,121 on an investment of $5,379, which is a return of 21% over 144 days.
Making money is always nice, but if this trade works out, you'll also be able to amaze your friends by telling them, quite truthfully, that you've been cleaning up in the market by using an off-center open-collar strategy.
Chart courtesy of stockcharts.com
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