Handbag and accessory maker Coach (NYSE: COH), one of the best-known names in high-end fashion, has also been one of the best-performing stocks in the bull market that started in 2009. From its bear market lows, Coach gained 599% before peaking in March.
Since then, the stock has pulled back and is trading 30% below its all-time highs. The chart below shows that the price could be headed even lower in the short term.
Despite the stock's recent struggles, Coach is still a great company for the long term. And at the right price, this stock is a buy. But right now it looks like it is a little too early. I think the holiday shopping season could lead to an additional sell-off in the stock that would push Coach shares down to where I would like to buy them.
As you can see in the chart below, since Coach peaked, competitor Michael Kors (NYSE: KORS) has been a market leader. The two companies are competing for many of the same customers, a demographic group that marketers call "aspirational consumers" who have limited discretionary income but want high-quality products. If Kors sees strong sales this holiday season, that revenue could come partly from customers choosing Michael Kors products over similar products that are available from Coach. But these customers often rotate between brands, and eventually they should return to Coach.
I think traders will also return to Coach, as Kors is expensive with a current price-to-earnings (P/E) ratio of 50, and a P/E of 30 times next year's earnings. At just 12 times next year's earnings, Coach offers investors a much better value. But I'd really rather try to buy Coach at a price equivalent to 10 times earnings, about $44, and with a naked put strategy that could happen.
When you sell a put option, you get income now and the right to buy the stock at a lower price before a certain date in the future. If the stock's price is below the option's strike price when the put contract expires, you will have to buy the stock at the agreed upon price. Therefore, you should only sell puts on stocks that you would like to own at strike prices that you feel make the stock a great buy.
Because Coach is a high volatility stock, the January 2013 puts are priced attractively. A deep-out-of-the-money put with a strike price of $44 is currently trading at about $1.25. If Coach falls below $44, we would get to own Coach at a purchase price of about $42.75, the exercise price minus the premium received when selling the option. At that price, Coach would be selling for less than 10 times next year's earnings offering a bargain-level price on this stock, which is likely to enjoy long-term earnings growth.
If Coach does not sell off, the premium would provide a return on the trade of about 14% on a fully margined position, an annual rate of return of more than 40%.
Action to Take --> Sell Coach Jan 2013 44 Puts between $1 and $1.50. Do not use a stop-loss. The puts will either expire worthless in January making the premium a 100% profit or you will be able to buy Coach at a price equivalent to $42.50 to $43 a share.
This article originally appeared on TradingAuthority.com: