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Archive for December 28th, 2011

New Trade – BBY

Posted by mounddweller on December 28, 2011

Fellow Traders,

I have a new trade, well actually trades, to share with you.  Today I executed the following naked put trades on Best Buy (BBY):

(1) STO 2 JAN $22.50 at $0.56

(2) STO 3 MAR $20 at $0.56

The JAN $22.50 puts give me a 2.49% ROIC with 24 days to expiration, albeit with very little downside protection.  My annualized return on this trade is 37.85%.  The MAR $20 puts give me a 2.80% ROIC with 80 days to expiration.  The annualized return is 12.78% with 13.04% downside protection.  My combined ROIC for both positions is 2.67%.

These are the first trades I’ve executed in my new trading/investment strategy.  First, let me provide a few more details about BBY then I’ll tell you more about the strategy.

Best Buy Co., Inc. operates as a retailer of consumer electronics, home office products, entertainment products, appliances, and related services primarily in the United States, Europe, Canada, and China.  The company was formerly known as Sound of Music, Inc. and changed its name to Best Buy Co., Inc. in 1983. Best Buy Co., Inc. was founded in 1966 and is headquartered in Richfield, Minnesota.

As you can see in the chart below Best Buy has solid financials.  Like most retailers it has slim net profit margins.  However, it has an outstanding return on equity (ROE), while maintaining a reasonable debt/equity ratio.  It has grown revenue substantially in the last 10 years.  In 2003 it began  paying a modest annual dividend of $0.20/share.  It has raised the dividend every year since.  It’s last quarterly dividend payment was $0.16/share implying an annual rate of $0.64/share.

Other financial information not shown above but worth mentioning are the fact that Best Buy generated $2.16B in levered free cash flow in the past twelve months.  Also, it has more cash in the bank than debt on its balance sheet.

Now, let’s take a look at the price history of Best Buy.  A 3-year price chart is presented below.

As you can see Best Buy is trading very near its 52-wk low of $21.79 which occurred on October 4.  It is also trading at 3-year lows.  That’s what I like most about this trade.  In my mind the downside risk is very low.  This is a key feature in my new trading strategy.

Now, having mentioned that let me briefly describe my new strategy.  My new strategy focuses exclusively on 76 large-cap companies which pay a substantial and growing stream of dividends.  I’ll soon be adding a new page to my web-site containing the names of these 76 companies.  For now, suffice it to say that Best Buy is on the list.

My plan is to only execute trades on these stocks when the price is at multi-year lows.  There are a great number of stocks that have cycled up and down over the past 12 years having essentially gone nowhere.  Anyone following a buy and hold plan has seen very little capital appreciation over the past 12 years.  Any gains received would have come from dividends.

The strategy will be to sell naked puts on the stocks when they are within 10-15% of the bottom of their 12-year range.   Depending on how the stock is acting, if the puts finish ITM I’ll either let the stock be put to me or roll it out a month or two.  I will use the proceeds from the put sales to reduce my overall net cost position in the company.  After accepting assignment I will begin selling OTM covered calls and will begin collecting the quarterly dividends.  I will sell the stock when it approaches multi-year highs OR if I feel I have captured a majority of the gains possible and a better use of my capital is available.

So, now having told you a little bit more about my strategy let me show you why I chose Best Buy as my first trade.  I’ve already told you Best Buy is at 3-year lows; however it get even better than that.  I’ve looked at 12-years of price history for Best Buy.  It is now in the bottom 10% of its price range for the past 12-years.

This chart gives me confidence that my downside risk is limited.  It shows me that over 97% of the time in the past twelve years Best Buy has traded at higher levels than it is now.   Best Buy has fallen over 50% since hitting a high of $48 back in late April of 2010.  It trades at less than 8x trailing earnings.  Everyone thinks the economy is headed for another recession and that holiday sales were weaker than anticipated.  They’re all saying SELL, SELL BEST BUY.  I say, be a contrarion, BUY BEST BUY while it is on sale.

Now, let me conclude by saying Best Buy may indeed have further to fall and that I may not have perfectly timed the bottom.  However, I again refer you back to my Decile chart.  12-years of price history is a long time, over 3000 days.  It has traded at less than $23.58 for only 95 of them.

Regards,

Troy

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