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Whole Foods

Yesterday one option trader placed a big bet for the rest of 2013 by buying 86,200 shares of Whole Foods at 89.82 and selling 862 Jan. 2014 98 calls for 6.50. This covered call position will break even as long as Whole Foods is above 83.32 (7% lower) one year from now. If Whole Foods rallies 9% to 98 by next January this trade will return 16% because of the call premium collected. This is a conservatively bullish trade that at once hedges downside risk while leaving room for growth. From a risk/reward perspective this is a great trade: it offers 7% downside protection and 16% potential upside appreciation. Additionally, holding a long dated short call against stock reduces day to day price fluctuations of the position and makes it easier to stick with the original trade thesis for the entire year even during whippy, volatile markets.

Despite liking the risk/reward of this trade, in order to justify putting it on I also need to like the underlying company. Whole Foods is a brand name I love but think its stock is a bit pricey to buy here. Currently Whole Foods trades at 4.4x book, 35.5 PE, and 1.4x sales. This is not an astronomically high valuation for a growth company, but certainly shows that the stock is not cheap. What I do like is that Whole Foods consistently posts higher gross margins (currently 36%) than its competitors like Safeway (27%) and Kroger (21%). The company also has a strong history of growth and offers a 0.9% dividend yield. The company’s growth has come from its ability to use free cash flow to open new stores in new markets. In doing so it has capitalized on the American trend of eating higher quality organic food and the willingness to pay a premium for it.

All in all I like Whole Foods but would not buy the stock without downside protection because of its full valuation at the moment. As a longer term investment I think Whole Foods has room to run and would be happy to capture a 16% return in a year. The 7% downside protection the call offers makes it easier to buy the stock at these levels and on a selloff I would look to accumulate a few more shares for the long term.

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