Top Trade Alert – Aug 31 2022 – LEVI

    Marilyn Monroe Levi Ad

    OK, let’s see who’s hot and who’s not:

    My premise here is that LEVI was hit by high cotton prices in Q1, peaking on March 31st. Q2 was considerably lower but they’ve also bounced back halfway to the top – so good but not great.

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    Cotton is 20% of the cost of the jeans so the variable of $80 cotton to $130 cotton in Q2 is 50/80 (62%) x 20% is a whopping 12% cost increase. Cotton did have a similar spike in 2011 – all the way to $200 and the company survived so I think the fears are overblown. Also, would people consider a 12% increase passed along outrageous? Not really.

    Currently we’re at $17.21, which is $6.9Bn and they made $554M last year and project $624M this year and $648M next year (20%!) on 5% rising sales. So far, they’ve made $196M and $50M – so we can assume they don’t have any hedges in place. Operating costs are $1.4Bn and 12% of that is $168M but we can assume they aren’t including all operating costs in their 20% number for cotton.

    Nonetheless – the numbers all track so, given an average cost of under $100 so far in Q3, we can apply the same 20/80 is 25% x 20% is 5% of $1.4Bn is $70M so I’d guess they’ll do $120M in Q3 but probably better as they’ve had time to pass along some of the higher costs and also to choose to make more of their less cotton-intensive items while I’m sure negotiating better discounts from their suppliers.

    If we say Q4 will still disappoint at $140M we have that + $120M + $196M + 50M = $506M, which is a 20% miss of estimates for the year but 25% more than the then-record $395M they made in 2019, when the stock was around $20.

    Since they are trading at maybe 13x – I think this is an excellent long-term entry point NOT because we think they’ll go to $25 but because they are very unlikely to go any lower and, therefore, great for our spread strategy.

    In the LTP, we already have 50 LEVI 2024 $18/23 bull call spreads at net $2.04 ($10,200) and we sold 20 2024 $18 puts for $4 ($8,000). The spread is now $1.55 and the puts are $3.55 for net $1,150 so we’re down a bit but still a good play but we should take the opportunity to roll our 50 2024 $18 calls at $3.05 to 50 of the 2024 $15 calls at $4.50 for net $1.45.

    So we’re spending net $7,250 to buy $15,000 worth of position and now we’re $2 ($10,000) in the money and in better position to sell short calls along the way.

    As a new spread, the $15 ($4.50)/20 ($2.35) bull call spread at $2.15 is a great deal and you can buy 40 of those for $8,600 and sell 20 of the 2024 $18 puts for $3.55 ($7,100) for a net $1,500 entry on the $20,000 spread that’s $8,000 in the money to start.

    As you can see from our original spread, we only committed $1,150 plus the margin for promising to buy $36,000 worth of LEVI and, now that the VIX is higher (it was $17 when we started on June 21st), we have an opportunity for a relatively inexpensive roll to a better spread.

    It’s all well and good to make 1,000% if all goes perfectly but now we’re in our original spread for net $8,400 and we were $1 out of the money on a $5 spread and now we’re $2 in the money on an $8 spread ($40,000).

    The Jan $19 calls are $1.10 and the Jan $17 calls are $1.90 and the $18 calls are $1.50 so, if we can get over $1.50 for the Jan $19s then we can sell 20 of them for $3,000 and then our net is down to $5,400 using 142 of the 586 days we have to sell.

    So you have to think of that $7,100 we’re spending as an investment to make our position rentable going forward. Like Air BNB for stocks!