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Kroger and Bare Escentuals

|Includes: BARE, COST, Kroger Co. (KR)

There’s nothing related between Kroger (NYSE:KR) and Bare Escentuals (BARE), just going to mention one of the companies, Bare Escentuals, we highlighted in a previous article on December 15, 2009 is going to be acquired by Shiseido. Shiseido is Japan’s largest cosmetic company and announced their plan to acquire Bare Escentuals on January 14, 2010, almost exactly one month after the large spike in call option volume occurred which we highlighted in the article. Bare Escentuals closed at $12.31 on December 15, 2009 and at $18.07 on January 15, 2010, a nice return of 47%.

With the beaten down U.S. dollar and stock prices of U.S. companies, it would not be surprising to see a few more acquisitions of U.S. companies by foreign companies, as U.S. companies are valued at quite a discount from what they were a few years ago.

Grocery retailer Kroger popped up on the stock option volume radar on Friday. In Kroger’s case, we don’t foresee an acquisition of Kroger by a foreign company or by any other company for that matter. However, “Kroger” and “high stock option volume” don’t often collide in the same sentence, so something is up.

Maybe investors are looking at defensive stocks, but no other grocery retailers appeared on the high stock options volume radar on Friday.

Kroger’s trailing twelve month [ttm] P/E of 86 is way out of kilter for a grocery retailer. For example Costco’s (NASDAQ:COST) ttm P/E is currently at 23. Based on this, Kroger’s stock price should be around $6 instead of its current price of $21.77.

The performance of Kroger’s stock price over the last couple of years has been dismal.
KR Chart

The stock option for Kroger experiencing the highest volume on Friday was the out-of-the-money April 22.50 call option, which has a bullish flavor.

With Kroger’s high P/E, a collar might be in order for Kroger, a covered call protected by a put option. A collar for July looks attractive with a %if unchanged potential return of 3.3% and a %if assigned potential return of 6.8%. The call option of interest to short would be the July 22.5 and the put option to purchase would be the July 17.5. The maximum potential risk for this position is about 17%.

The profit and loss chart for one contract of this collar position is shown below:

KR Chart

To enter the collar position an investor would purchase the stocks in multiples of 100 shares for their trading portfolio and sell one call option and purchase on put option for each 100 shares of stock purchased for their personal stock portfolio.

Disclosure: No position in KR, BARE or COST.