10/31/12 Covered Call Pick: Home Depot (HD)

Home Depot (HD) is a big box store that supplies building materials, home improvement, and lawn and garden supplies and tools to consumers all across the United States as well as in Mexico, Canada, and Puerto Rico. The company, founded in Marietta, Georgia in 1978 has over 2,200 locations and is America's largest home improvement retailer.

Home Depot has a market capitalization of $90.51 billion with 1.5 billion outstanding shares.

HD currently pays a quarterly dividend of $0.29 for a current yield of 1.9%.

With a beta of 0.77, HD trades with approximately 20% less volatility than the current market.

This buy on Home Depot is another play on the good housing numbers from last week. Last week we discussed some of the better housing numbers we saw, and briefly discussed how we saw a turnaround in the housing market, so we won't go over that again here. With the housing market improving, there are plenty of people that will be looking to fix up their house in order to sell it, and in terms of DIY, Home Depot is easily the leader. They have seen a measure of success significantly above their leading competitor, Lowe's (LOW), with the stock up over 42% year-to-date.

HD has had some trouble recently in terms of their expansion abroad. They originally opened up seven big box stores in China, but as of September 13th, have decided to close the stores due to a lack of "DIY mentality" in China. While the foray into that emerging market didn't end in HD's favor, it is wise that they are cutting their losses now rather than trying to force a cultural change that would be a long time in coming, if it came at all. Rather, they are refocusing themselves in their home base, and we believe they will be able to do this with great success. In terms of recent developments, the devastation from Hurricane Sandy will end up profiting the company. Many home insurance companies do not cover flood damage in their plans, forcing home owners to buy it separately. For those that haven't, damage from a storm such as Sandy can be very costly. DIY fixes will be more favorable in order to reduce these costs, and people in this country think of HD when they think of DIY. In addition, plenty of people experienced (or are still experiencing) a loss of power. This will lead many to buy a portable generator to prevent a future situation where they are without power, and Home Depot is the easiest place to purchase one.

Just like with PNC, we are optimistic on the housing upturn, and want to realize some of the capital appreciation that is possible in the stock. Thus we are recommending buying HD, and selling the May 2013 $65 out-of-the-money Call.

(Stay tuned later today for updated Covered Call Strategies on PG and DD!)


Scenario:

  • Buy 100 shares of HD @ $62.47 = $6,247 + Commission ($12.95) = $6,259.95
  • Write 1 HD May 2013 $65 Call @ $254 - Commission ($8.70) = $245.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns. 


Static Return (Not Called):

(Call + Dividend)/Stock Price   X    (Days/Year)/Days to Expiration

(2.45 + (2*0.29))/62.60      X    (365)/198

8.92% Static Return


If-Called Return:

(Call + Dividend + Strike Price - Stock Price)/Stock Price       X        (Days/Year)/Days to Expiration

(2.45 + (2*0.29) + 65 - 62.60)/62.60       X      (365)/198

15.99% If-Called Return



Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarentee the above, or any, result. All investment decisions should be made based upon individual’s personal investment goals and risk tolerance.

 

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