Alibaba vs. J.C. Penney
Slowing vs. Explosive Growth
Calls and Put Options
When I'm looking to buy a stock or put on an option trade, I don't look for a company like J.C. Penney that's well known by my grandparents but is a slowing business. I look for a company like Alibaba that's on the verge of disrupting the world through innovation and growth.
In October, Cabot President and Chief Investment Strategist Timothy Lutts wrote about his road trip from Salem, Massachusetts to Savannah, Georgia and back. In one of his stories from the road, Tim compared historic Wilmington, Delaware to new and booming Cary, North Carolina. This was an interesting look at old and slowing compared to new and growing.
Here is what Tim had to say about Wilmington:
"Downtown Wilmington has a lot of tall buildings where the bankers work. As students of business know, Delaware is a great place to incorporate a business, regardless of where you actually are. As a result, Wilmington is the national financial center for the credit card industry. Bank of America (formerly MBNA Corporation), Chase Card Services (part of JPMorgan Chase & Co., formerly Bank One/First USA), and Barclays Bank of Delaware (formerly Juniper Bank) all have their headquarters in Wilmington.
"But I had a very hard time finding any real middle-class people in Wilmington. To be blunt, it seems like they've all moved to the suburbs, leaving the downtown to people too poor to have any choice. As a result, Wilmington feels sort of hollowed out.
"A few stats tell the story:
Wilmington's population peaked at 112,000 in 1940. Now it's about 71,000.
Median household income is $32,000, with 28% of the population living below the poverty line.
March 2014, Movoto Real Estate rated Wilmington the most dangerous small city in the country.
Then Tim went on to talk about Cary, North Carolina.
In 2000, the population was 95,000. Now it's topped 150,000.
Cary was the fifth fastest-growing municipality in the U.S. in 2006-2007.
It's ranked the third safest among U.S. municipalities with populations of 100,000 to 499,999.
The median household income for Cary as of 2011 was an astounding $110,609.
More than 60% of adults possess a bachelor's degree or higher.
And all that is mainly because of the influx of skilled, educated workers attracted by private industry.
"But there are two things missing in Cary that make it a place I could never live for long. One is a substantial historical downtown. Cary is mainly one big affluent sprawl-and some people love that. But as a product of one of the more history-laden cities in the country, I like old buildings, and most of Cary is just too new for my taste."
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What is so interesting about what Tim wrote about preferring historic Wilmington to booming Cary is that at heart Tim is a growth investor. For example, Tim found Tesla Motors (TSLA) when it was on the verge of explosive growth, and has countless other stocks that he saw amazing potential in. Like myself, he looks for companies or stocks on the verge of breakouts. So why would Tim prefer to live in an old city vs. a city on the verge of potential greatness?
This comparison has parallels in stocks in many sectors.
Why buy a formerly good stock like Coach (COH) (that's now struggling) when you can buy the "next big thing" in Under Armour (UA)?
International Business Machines (IBM) was once a leader. But wouldn't you rather buy stocks like Palo Alto Networks (PANW) that are supplying the next generation of important technology?
And why buy slowing J.C. Penney (JCP) when you can buy the amazing growth story behind Alibaba (BABA)?
When I want to put on a position in a stock that I think is on the verge of a collapse or a breakout I use call and put options. If I wanted to short J.C. Penney, I would buy puts. If I wanted to get long Alibaba, I would use calls.
For example if I thought that JCP was in long-term trouble and wanted to put on a bearish position, I could buy a put. Why would I buy a put? Most investors cannot short stocks, as their brokerage house would deem that they have unlimited upside risk. On the other hand, when a trader buys a put, the most he can possibly lose is the premium paid.
With JCP trading at 7.30, I could buy the January 7 Puts that expire in January of 2016 for $1.50, for a capital outlay of $150. (Note that each call or put represents 100 shares of stock. If we pay $1.50 for the put, that $1.50 is actually multiplied by 100. So the total cost is $150.)
If JCP were trading below $5.50 by January of 2016, my trade is profitable and I would make money all the way until the stock reached zero. If JCP were trading above $7, the most I can lose is the $150 premium paid.
On the other hand, if I wanted to buy a stock on the verge of tremendous growth like BABA, I would buy a call. Why a call? If I wanted to buy 100 shares of BABA, with the stock trading at 111, that would cost me $11,100. On the other hand, if I were bullish on BABA, I could buy a call for a fraction of the cost.
For example, I could buy BABA March 115 Calls for $8.00, or a total capital outlay of $800. If BABA is trading above 123 on March expiration, my trade would be profitable with unlimited upside. However, if my long-term bullish stance is wrong, and BABA isn't the next great growth stock, and the stock is trading below the strike price of the call I bought, or 115, the most I would lose is the $800 I spent on this call.
While Tim may like old and historic for a place to live, I know he, like myself, would rather invest in the next great growth story.
Have a safe and happy Thanksgiving!
Your guide to successful options trading,
Chief Analyst, Cabot Options Trader/Cabot Options Trader Pro