DGI Adventure 11-09-16 Sold Cash Secured Put + Investment Thesis (Revisited) – Gap, Inc. (GPS) – $22.00 strike – Dec 02 Expiration


This trade was actually executed on Thursday 11/03/16. I didn’t get a chance to write about it until today.

The last time I sold a put against GPS shares was in early September, and I mentioned that I was still riding on the coattails of the original investment thesis that I had published a year earlier.

It’s time to revisit that investment thesis. Please visit the core philosophies article on my process for a deeper explanation of the components of this article.

I have updated the portfolio and income tracker back at the mothership to reflect this position.

Dividend Cycle

GPS went ex-div a month ago on 10/03/16, so the next one should be at the beginning of next year.

In 2016, the company extended its dividend contender status to 12 consecutive years of increases, albeit in the most pathetic way possible. If you look at the recent dividend history, the payout has been stuck at $0.23 since April of 2015, and they didn’t raise it at all in 2016.

So how did they extend their streak? On a technicality. Here’s a table that might help illustrate that technicality:

The Dividend Champions, Contenders and Challengers list compiled by David Fish considers a streak active so long as the cumulative regular dividend payout in a given calendar year is greater than the previous year. In 2016 the cumulative dividends were $0.92/share which was $0.01/share more than 2015 (a 1.1% YoY increase).

So technically speaking, GPS could keep the payout at this $0.23/share level for the next three quarters, and then increase it to $0.24 for the Q4 2017 distribution, which would make the 2017 cumulative payout $0.93 (also a 1.1% YoY increase). I don’t think they’ll do that, but who knows. Their balance sheet is certainly healthy enough to support a much more aggressive growth rate.

I guess it could have been more pathetic. They could have raised it by a fraction of a cent…

This trade will expire before the next ex-div date and the premium exceeds the quarterly distribution.

Investment

The QC (Quantitative Case)

*Note: Technically the current P/E exceeds the 5 year average, which means it’s “failing” this metric. But the strike price is really far below the market price. If shares drop that much, and I end up getting assigned, the P/E will be well below the 5 year average.

SPL (Strike Price Logic)

I own 154 shares in the taxable account (labeled account #6 in the portfolio tracker back at the mothership.) The cost basis on those shares is $21.69.

Of course I have to pay capital gains taxes on any dividends that I collect on those shares, which means that the type of account they’re in is hindering the investment’s growth rate.

Ultimately I’d like to get assigned and hold shares in the tax-advantaged beneficiary IRA rather than the taxable account. If it’s possible I’d like to make that switcheroo at a similar or even slightly lower cost basis. But because of the tax-adjusted yield effect, I could stand to make that trade well above $21.69/share. $22 is close enough for me.

The company is going through a bit of a rough patch right now, but I think they’ll be able to get out of it, and over the long term a 3% yield seems like a pretty fair value, so really anything under $30 is probably pretty decent.

Just because I would be willing to buy shares at a higher price, doesn’t mean I have to. As long as Mr. Market continues to offer options premiums worth 15%+ annualized and double digit downside protection, I’m going to keep taking it.

QWaF (Qualitative Warm and Fuzzy)

See the original investment thesis for qualitative analysis. I don’t really think much has changed.

CPR (Cold and Prickly Risks)

See the original investment thesis for qualitative analysis. I don’t really think much has changed.

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