Stock Options To The Rescue! Safeway (SWY)

| October 12, 2012 | 0 Comments

SWY OptionsToday we’re going to look at Safeway (SWY) and how you can use options to reduce your cost basis and profit from the recent decline in the stock.

Here’s what happened…

SWY shares are down 5% from $16.29 to $15.50 after reporting 3rd quarter earnings earlier this week.  The company fell short on revenue expectations but was able to beat earnings estimates.

Here’s the deal…

The grocery store said sales declined 0.2% last quarter because they didn’t increase prices as much as expected.  

However, earnings per share came in at 45 cents.  This easily beat the 42 cent estimate and was up 18% from the same quarter a year ago.

SWY’s earnings beat isn’t as good as it looks.  Sure they beat earnings per share estimates, but it wasn’t because they made more money.

In fact, net income fell to $108 million from $130 million in the same quarter.  The only reason EPS increased was a massive stock buyback that reduced outstanding shares by 31%!

So far this year, the company has repurchased 57.6 million shares for $1.2 billion.  And they have $0.8 billion authorized for additional buybacks.

Here’s the kicker…

Safeway’s losing ground to bigger retailers like Target (TGT) and Wal-Mart (WMT) who are making a big push into the grocery business. 

In order to stem the tide, SWY rolled out a new customer loyalty program last quarter. 

The “Just for U” program is designed to get customers to shop at their stores more often and buy more when they’re there.  So far the program has been successful in modestly boosting sales.  But it’s come at the expense of higher operating costs.

In my opinion, the program won’t be enough to counteract the impact of losing sales to TGT and WMT.  But it will likely stem the tide enough to end the stock’s 30% slide from the 52-week high. 

Here’s what to do now…

Let’s assume you invested $1,630 to buy 100 shares of SWY at $16.30 before earnings.  So you’re down about 5%.  But you don’t want to sell the stock because it has a hefty 4.5% dividend yield.

Selling the SWY March 2013 $17 covered call can rescue this trade

Right now you can sell the March 2013 $17 call for $0.75 for every 100 shares you own.  So you’ll collect $75 in option premium for selling one contract.  And you’ll keep the 100 shares of SWY so you’ll collect $35 in dividend payments before the options expire.

Dividend payments and option premium will reduce your cost basis $110 to $1,520.  So you’ll own 100 shares of SWY at an average cost of $15.20.

There are two possible outcomes for this trade…

First, if SWY is above the $17 strike price, the option holder will exercise their right to buy your stock at $17 per share.  Your 100 shares will be called away or sold for $1,700.

But that’s just fine by us… Remember, we reduced our cost basis to $1,520.  So we’re out of the trade with an 11% profit of $180.

However, a more likely scenario in my opinion is SWY never reaches $17. 

Don’t forget, SWY is losing ground to bigger competitors and the new customer loyalty program is yet to be proven effective.  That’s likely to keep a lid on any positive momentum in the stock.

If SWY stays below $17 until March, the option will expire worthless.  You’ll get to keep the $75 in option premium, the $35 in dividend payments, and you’ll still own the stock at an average price of $15.20 per share.  

In my opinion, selling a covered call against your SWY stock holdings is better than selling or doing nothing.  This strategy reduces your cost basis and puts you on the fast track to turning this losing trade into a winner.

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.