I Am Still Feeling 'Lucky’
This is how I'm lining up a ‘rinse, wash, and repeat’ covered call trade on Smith & Wesson.
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In late January, I highlighted a covered call trade around Smith & Wesson SWBI whose .357 Magnum Dirty Harry made famous in the early 1970s. Those covered call holdings expired in the money on Friday. And as my late father liked to quip "If it broken, don’t fix it." Therefore, we are going back to the well and lining up another covered call trade on this small arms manufacturer.
Smith & Wesson has been around for more than 140 years now. It makes a variety of firearms including various pistols, rifles and shotguns that are sold to hunters, for home defense, as well as to law enforcement agencies. The company also sells accessories such as magazines, suppressors, and handcuffs. The stock has moved up slightly since I last highlighted it at the start of this year. The stock trades around $13.50 a share and sports an approximate market capitalization of $600 million.
The company is quite shareholder friendly. It bought back $13 million worth of its own stock in the most recently completed quarter and recently added $50 million to its stock buyback authorization. The stock also sports a dividend yield just north of a 3.9%. The company also has a solid balance sheet.
Smith & Wesson has now largely completed the move of its long-standing headquarters out of Massachusetts to Tennessee. This provided a more efficient cost structure and lower regulatory burden as well.
Sales were a bit soft over the summer due to the economic challenges many of the company’s core customers are facing and there was also some higher-than-expected inventory build. Gross margins did improve in the latest quarter and management expects full-year growth in revenue and earnings.
The company should have some tailwinds that will play out in the coming quarters, in my view. Concerns about rising crime levels, mass migration and growing political discord remain top of mind for many Americans, unfortunately.
Finally, the valuation around Smith & Wesson is reasonable in what I view as an overbought market. Especially so given its nearly four percent dividend yield. After posting earnings of $0.72 per share in FY 2024 (the company’s fiscal year begins April 1), Smith & Wesson is expected to deliver EPS of $1.00 this fiscal year and post another 20% earnings increase in FY 2026. Sale growth for both fiscal years is estimated to be in the mid-single-digits.
Option Strategy
Here is how I am maintaining a position in SWBI using a covered call strategy. Remember, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Selecting the March $13 call strikes, fashion a covered call order with a net debit in the $10.95 to $11.25 a share range (net stock price - option premium).
This strategy provides downside protection of around 18% over the option duration, including the two quarterly dividend payouts of $0.13 a share. It also provides upside potential of roughly the same amount of downside protection, including dividends over the six-month option duration even if the stock falls slightly over that time.
