(Michael Khouw offers options analysis and insight at Action Alerts OPTIONS. You can sign up for a trial subscription here.)
NEW YORK (Real Money) -- Options are powerful tools for investors to enhance returns, reduce risk and produce income. But as powerful a tool as options are, sometimes when you're carrying a hammer, everything begins to look like a nail.
I'm going to beg your indulgence because we have an actionable trade and a lesson on when NOT to use options. If you're only interested in the trade idea, I'll tell you upfront. Buy Office Depot (ODP) . This is a longer-term trade and I have a $9.50 price target.
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If you want to know why I'm bullish on ODP, and why options are not the way to play it this time, read on.
Office product warehouse stores such as Office Depot and Staples (SPLS) might not seem like a particularly exciting segment in retail. A narrow-margin business to begin with, these companies have to contend with competition from broader big-box retail stores such as Walmart (WMT) and Target (TGT) and, increasingly, from online retailers and direct sales.
If your printer cartridge is due for replacement, you have likely seen the pop-up message asking if you wanted to order more online. Automatic notification that you are running low on supplies with click-to-order features are a convenient, expanding trend. Clearly, Amazon (AMZN) is also a material threat.
Still, even in an industry with relatively low margins (about 4%) and no or low growth, the right plan and execution can really pay off. The acquisition of OfficeMax by Office Depot is proving to be that type of game-changer. After nine quarters of no/low EBITDA (earnings before interest, taxes, depreciation and amortization), the earnings indicate they have turned the corner.
ODP actually beat estimates when it reported 3Q 2014 earnings Nov. 4. While management remained pretty conservative, it's clear that some of the synergies that justified the merger of Office Depot and OfficeMax are starting to materialize as they doubled adjusted operating income in the third quarter, improved gross margins and raised guidance by about 4% to $265 million for the full year.
On the downside, it did see a 4% sales decline. But half of that was explained by planned store closings. One year after the merger, it may only be scratching the surface of what's possible.
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