Stock Options To The Rescue! Family Dollar Stores (FDO)

| October 5, 2012 | 0 Comments

FDO OptionsToday we’re going to look at a stock replacement strategy on Family Dollar Stores (FDO).  It allows you to reduce your risk, lock in profits, and gives you upside potential. 

Here’s what happened…

Family Dollar Stores reported record sales and earnings results earlier this week.  It was their fiscal 2012 fourth quarter.  And their stock has jumped 6% from $66 to $70 following the release.

Here’s the deal…

Sales at the discount retailer surged 10.8% to $2.36 billion last quarter.  And comparable same store sales jumped 5.4%.  That’s pure and simple organic growth. 

The strong sales numbers trickled down to earnings as well.  They earned 75 cents per share last quarter.  It was an increase of 13.6% from 66 cents earned in the same quarter last year. 

However, the company was forced to cut their earnings guidance for next quarter.  They now expect to make between 69 cents and 78 cents.  A two cent per share hair cut from their previous guidance of 71 cents to 81 cents.  And they issued full year fiscal 2013 guidance of $4.10 to $4.40 per share.

Here’s the kicker…

Family Dollar is one of the fastest growing discount store chains in the US.  And fiscal 2012 was a remarkable year for them. 

They’re clearly benefiting from a sluggish economy that’s yet to generate enough jobs to put a dent in the high unemployment rate.  It’s forced many consumers to seek out bargains on everyday household items just to make ends meet.

But just because consumers are looking for bargains doesn’t mean they’re willing to go anywhere to find them.  Even budget conscious consumers want choices and an enjoyable shopping experience.

And FDO has done an excellent job of connecting with their target consumer.  

As Howard R. Levine, Chairman and CEO put it, “We expanded our merchandise assortment to increase our relevancy to our customers; we continued to improve the shoppability of our stores; and we repositioned our leadership team to better support our growth.”

I think FDO has a great future.  They’re executing a proven growth strategy that should continue to fuel strong earnings and dividend growth for years to come.

Here’s what to do now…

Let’s assume you bought 100 shares of FDO at $62 when the stock pulled back to the 200-day moving average at the end of August.  And you were looking to turn a quick profit on the stock.

Selling your FDO stock and buying the FDO January 2013 $70 call option for $2.95 is a great way to lock in profits, reduce your risk, and give you upside potential if FDO continues to move higher.

Right now you can sell your FDO stock for an $8 per share profit.  That’s an $800 profit on your FDO investment.  And buying the FDO January 2013 $70 call option for $2.95 will cost you $295.

In essence, you’re giving up 37% of your profits in order to lock in a $505 profit on FDO ($800 stock profit – $295 option price).  That’s still a solid 8% profit on your original $6,200 investment.  And that’s your worst case scenario.  No matter what happens, you’ve guaranteed yourself a $505 profit.

And the call option gives you the ability to increase those profits.   

The breakeven on your call option is $72.95 ($70 strike price plus the $2.95 premium).  If FDO is at exactly $72.95 when the option expires in January, you’ll get back your $310 investment.  And your return on investment will be back to what it would be if you just sold the stock today.

But if FDO rallies beyond $72.95, your total profits will be more than if you just walked away today.  In fact, if FDO is trading from $75 when the option expires, your total return will shoot up to over $1,000.

As you can see, replacing your FDO stock holdings with a call option allows you to lock in profits, reduce your risk, and still gives you upside if the stock continues to rally.

Good Investing,

Corey Williams

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Category: Stock Options To The Rescue!

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.