Two trading themes to watch

Key Concepts

• Picks and Shovels Play: An investment strategy focusing on companies that provide the essential tools or raw materials for an industry rather than the end-product manufacturers.
• Bull Call Spread: An options strategy used when a trader expects a moderate rise in the price of an underlying asset.
• Selling Puts (Cash-Secured Puts): An income-generating strategy where the investor agrees to buy a stock at a specific "strike price," effectively getting paid to wait for a lower entry point.
• Air Rights: The legal right to control and develop the empty space above a property, a significant asset in high-density urban areas like Manhattan.
• Intrinsic Value vs. Market Valuation: The discrepancy between a company’s market capitalization and the actual liquidation value of its underlying assets (real estate).

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1. Alcoa (AA): The Aluminum Play

Phil Davis identifies Alcoa as a strategic "picks and shovels" investment due to the critical role of aluminum in modern technology, specifically heat exchangers for space exploration and industrial applications.

• Investment Thesis:
  • Production Advantage: Alcoa possesses unique local production capabilities and idle smelters that can be reactivated, insulating them from tariff-related supply chain issues.
  • Market Dynamics: Demand for aluminum is growing exponentially, while physical supply faces inherent limitations.
  • Valuation: Trading at approximately 14x earnings, the market has yet to price in the long-term supply-demand imbalance.
• Trade Structure:
  • Strategy: 2028 $60/$85 Bull Call Spread.
  • Execution: Selling $55 puts to generate income (effectively promising to buy the stock at $44, a significant discount to the current $70 price).
  • Income Generation: Selling quarterly $75 calls to capture premium income.
  • Potential: The spread costs $3,775 with a $50,000 total value, offering a potential upside of ~1,000%.

2. Macy’s (M): The Real Estate Arbitrage

Davis argues that Macy’s is fundamentally undervalued because the market ignores the massive worth of its real estate holdings.

• Investment Thesis:
  • Asset Value: The company owns its buildings outright, including a flagship Manhattan block appraised at $5 billion.
  • Air Rights: The potential to develop additional square footage above the Manhattan store adds an estimated $4 billion in value.
  • Liquidation Potential: With a total company market cap of $5.7 billion, the real estate value (potentially $20 billion if all locations were liquidated) suggests the retail business is essentially being acquired for free.
  • Operational Health: The company remains a solid retailer, generating $500 million in annual profit.
• Trade Structure:
  • Strategy: 2028 $15/$22 Bull Call Spread.
  • Execution: Selling $20 puts to lower the cost basis.
  • Income Generation: Selling quarterly $22 calls and $20 puts.
  • Potential: With a net cost of $5,950, the strategy aims to generate $4,000 in quarterly income, with a total potential return of approximately 700%.

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Risk Management and Methodology

• The "Swing" Philosophy: Davis emphasizes that investors must aim for high-percentage returns (e.g., 1,000%) to realistically achieve substantial gains (e.g., 500%), acknowledging that not every trade will hit its maximum target.
• Risk of Put Selling: The primary risk in both strategies is the obligation to purchase the underlying stock if it falls below the strike price of the sold puts. Davis mitigates this by selecting strike prices that represent a "huge discount" to current market values, making the obligation to own the stock an acceptable outcome.
• Income-Focused Rolling: Both trades utilize a quarterly cycle of selling calls and puts to generate consistent cash flow, which offsets the cost of the long-term bull call spreads.

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Synthesis

The core takeaway from the discussion is the importance of looking beyond standard P/E ratios to identify "hidden" value. For Alcoa, the value lies in physical production capacity and supply-demand constraints. For Macy’s, the value lies in tangible, prime real estate assets that exceed the company's market capitalization. By utilizing complex options structures—specifically bull call spreads combined with the sale of puts—Davis aims to create high-upside, income-generating positions that provide a margin of safety through discounted entry points.