Option Investor

New Portfolio Position: MHK "Bear-Call" Spread Projected Gain = $225

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MHK - Mohawk $83.04

Mohawk Industries (NYSE:MHK) is engaged in the production of floor covering products for residential and commercial applications in the United States through its three primary operating subsidiaries: Mohawk Carpet, Aladdin Manufacturing and Dal-Tile International. The Mohawk segment designs, manufactures, sources, distributes and markets its floor covering product lines, which include carpet, rugs, ceramic tile, hardwood, resilient and laminate, in a range of colors, textures and patterns for residential and commercial applications. The Dal-Tile segment designs, manufactures, sources and markets a broad line of ceramic tile, porcelain tile and natural stone products used in the residential and commercial markets for both new construction and remodeling.

Shares of MHK have slumped during the past two weeks due to the rising price of oil and chemicals, which constitutes almost 60% of the company's costs for floor coverings. In the most recent quarter, net income was flat and operating margins dropped by a full percentage point when compared to the previous year. The mediocre fundamentals have forced Legg Mason analysts to cut their rating on Mohawk, saying "margins at the flooring company will be pressured until oil prices begin to decline."

Our outlook for the issue is also "bearish" and we believe the company's quarterly earnings report, due on 4/21/05, will be less than outstanding. Traders who agree with this assessment should consider "target-shooting" a viable credit in the suggested position. Since the bid/ask spreads are large in the OTM options, a "net-credit" order is the most conservative way to enter the spread. However, the use of individual orders (for the long and short options) may be the only way to achieve the target price if the underlying issue remains in a relatively small range during the next few sessions.

Fundamentals Chart Earnings Dates Analyst Ratings

PLAY (conservative - bearish/credit spread):

BUY CALL MAY-95.00 MHK-ES OI=348 ASK=$0.25
SELL CALL MAY-90.00 MHK-ER OI=655 BID=$0.60

POTENTIAL PROFIT (X 5 contracts) = $225
MARGIN REQUIREMENT (X 5 contracts) = $2275
COST BASIS = $90.45


Once the position is open, traders should place a (contingent) order to close the short ($90) call options if the stock moves above $88.25. Future adjustments to this loss-limit/exit point will be posted in the MCM Newsletter.

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