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Carmakers reported surprisingly strong U.S. light-vehicle sales in May with a seasonally adjusted annualized rate of 17.71 million units, the highest since 2005. Aided by five weekends, including the usual Memorial Day blowouts, daily sales of 62,558 units were 5.5% higher than the same month last year.
Besides great weather for car shopping, manufacturers have benefited lately from stronger employment, low gasoline prices and increasing credit availability.
But you wouldn't know it to look at their stock prices. In fact, the First Trust NASDAQ Global Auto ETF (NYSE: CARZ) sank 2.7% over the week after the May sales report was released.
Investors have been worried that strong economic data would encourage the Federal Reserve to raise interest rates and choke off big-ticket purchases like new cars. While this may eventually be the case, higher rates could actually be a tailwind for automakers in the second quarter.
Higher Rates May be Good Thing for Near-Term Investors
A surge in interest rates could end up helping car manufacturers in a way that investors have yet to grasp. The rate on the 10-year Treasury has shot up from 1.87% at the beginning of the quarter to around 2.5%.
Consumers have taken notice and are rushing to get their big-ticket financing before interest rates go any higher. This may have contributed to May auto sales as it's certainly helped drive home sales. New single-family home purchases jumped 2.2% in May -- the fastest pace in seven years -- while sales of existing homes hit their highest level since 2009.
I expect auto sales to show continued strength in the next few months as customers take advantage of low rates while they can, which would be reflected in the next quarterly earnings reports. While higher rates may eventually weigh on auto sales, the near-term outlook looks good.
Amplify a 6.4% Stock Move Into 114% Profits
Shares of Ford Motor Company (NYSE: F) are down 11% over the past year and have been weak recently on production delays at the Kansas City F-Series plant. The company told dealers production would pick back up after May. Sales for the F-Series were down 10% in May, so there's a good chance that June sales could jump as inventory ramps back up and dealers push the model.
Foreign sales could prove to be another bright spot in Ford's second-quarter report, which is scheduled to be released July 28. The U.S. dollar finally halted its upward pitch in March and has come down slightly against foreign currencies since the beginning of the quarter. This should help U.S. car companies compete in foreign markets. Sales in Europe were 22% of 2014 total revenue, and I expect the recent green shoots in economic growth to start showing through in positive sales growth.
Beyond the potential for stronger June/July sales and a recovering European operation, recent cost-cutting and increased capacity utilization in China could finally stem the three-year slide in operating profitability. The company's operating margin has ticked up to 2.4% over the past two quarters and further gains could turn investor sentiment higher.
F is currently trading at $15.40, and an earnings beat in late July could easily take shares to my target of $16.39, which is just 6.4% above current prices.
Using options, I can leverage a small potential move in Ford's stock into a huge profit. Using a similar strategy, I've seen options prodigy Jared Levy turn a $180 bet on a little-known water ETF into a 28% gain in 63 days and a $525 bet on Valero Energy (NYSE: VLO) into a 91% profit in 15 days.
Traders can buy the F Aug 15 Calls for around $0.65 each ($65 per contract). That's a call option on Ford with a strike price of $15 and an expiration of Aug. 21. My breakeven price of $15.65 is just 1.6% higher than the market price, and my upfront investment of $65 per contract is a fraction of what it would cost to buy 100 shares directly. The options have a delta of 64, which means the call options should increase by $0.64 for every $1 increase in the shares.
If shares hit my target price of $16.39, the options would be worth at least $1.39 for a gain of 114% on the trade. That's 18 times the 6.4% return you'd book if you bought the shares outright. I recommend setting a good 'til cancelled (GTC) sell order at $1.39 for the options after opening the position.
The August options allow us to benefit from the upcoming earnings release and further sales strength on the increase in interest rates, as well as any good news from Europe.
Buying options on stocks is an amazing way to leverage a small amount of capital into big profits. Jared does this every week in his trading service, Profit Amplifier, using a technique he created that has delivered average annualized gains of 123%. To learn more about it or get his latest recommendation sent directly to you, follow this link.
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