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About this time of year, retailers begin coming out with their holiday shopping forecasts and investors start flocking to retail stocks.
Unfortunately, the upswing in share prices is sometimes short-lived as holiday sales fail to materialize or longer-term fundamentals come back to weigh on stocks. That is why I always look for a long-term catalyst when I go shopping for holiday retail stocks.
My preferred method is to use a short-term options strategy to make a quick profit on the near-term euphoria. But I want to know that, if I do end up taking a position, the long-term catalyst should allow us to book a healthy profit.
News released from a leader in two industries in late September has given us just that kind of opportunity. With one of my favorite options strategies, we can take advantage of near-term upside for a 6.5% gain in less than two months or get shares at a discount for long-term growth.
Two Great Companies in One
eBay (NASDAQ: EBAY) recently bowed to activist pressure to spin off its extremely profitable PayPal unit. The company was reluctant to let go of the commerce giant at first, but decided it would be better to unlock shareholder value by letting both segments operate independently.
While for years eBay investors have feared competitors like Amazon.com (NASDAQ: AMZN) and more recently Alibaba Group (NYSE: BABA) would take market share, the online auctioneer and marketplace grew revenue by 10% in the past 12 months on its 149 million active buyers. Overall online retail sales are expected to grow by a compound rate of 9.5% a year through 2018, according to Forrester Research, so even with greater competition, eBay has room to grow.
PayPal has been a great acquisition for eBay, growing revenue by a compound rate of 46% a year since 2002. While PayPal may be growing at a faster rate compared with eBay's 26% a year, eBay still sports the more attractive margin, turning a 35% profit against PayPal's 25% profit margin.
The PayPal spin-off is scheduled to be completed sometime in the second half of 2015 and will be tax-free to shareholders.
Near-Term Upside on This Long-Term Play
The September announcement of the PayPal spin-off sent EBAY rocketing 7.5% higher on the day. The stock has since come back down a little. In addition to the longer-term upside from the spin-off, the current price makes for a great opportunity to profit from a short-term catalyst.
While holiday spending disappointed investors last year with growth of just 3.1%, there is good reason to think this year's spending could be a lot higher.
The U.S. economy has created 2 million jobs this year in the nine months to September, and the unemployment rate dropped to 5.9% last month.
Beyond strong job gains, the national average price of gasoline has plummeted to $3 a gallon, 8% lower than the $3.27 per gallon at this time last year. Savings on gasoline should make consumers more willing to spend this holiday shopping season.
The National Retail Federation is forecasting 4.1% growth in holiday spending, but I think it could be even higher.
Over the past 10 years, shares of EBAY have increased an average of 2.8% in the last two months of the year. In the past three years, the average has been an impressive 14.6%. Increased retail spending this year could drive another big gain.
Generate 6.2% and Get the Chance to Buy EBAY at a Discount
But why jump into the shares at the market price when you can take a position at a discount using a put selling strategy?
By selling a put option on a stock, we are agreeing to buy 100 shares per contract at the option's strike price if shares are below that price when the option expires. For accepting the obligation, we are paid a premium, which lowers our cost basis even further. And if shares are above the strike price at expiration, that premium is ours to keep free and clear.
With EBAY trading at $52.50 at the time of this writing, we can sell the EBAY Dec 55 Puts for a limit price of $3.20 per share ($320 per contract). If the stock closes below the $55 strike price at expiration on Dec. 20, we will be assigned shares at that price. Since we received $3.20 in options premium, our actual cost is $51.80 per share.
We want to make sure we have enough money in our account to cover the purchase. So for each contract we sell, we will need to set aside $5,180 of our own capital plus the $320 received from the put sale.
The strike price is 4.8% above where the stock is now, but our cost basis actually represents a 1.3% discount to the current price.
If EBAY closes above $55 on expiration, we keep the premium for a gain of 6.2% in just 47 days. If we were able to make a similar trade every 47 days, we would generate a 48% annual rate of return.
Higher holiday retail sales could present a nice near-term catalyst for the stock, while I see limited downside over the next year as investors line up to take advantage of the PayPal spin-off. A put selling strategy allows us to profit from a near-term move while potentially getting the shares at a discount.
Note: Selling puts is one of the best strategies for generating consistent, market-beating returns. My colleague, Amber Hestla, has generated 54.5% average annualized gains with this strategy on her way to a perfect 71 for 71 track record. You can learn exactly how to make the same trades -- plus details about her first 52 successful trades -- by following this link.
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