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It’s a Golden Era for Gun Sales. Here’s How to Play It.

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Gun sales are surging, and so are the stock prices of major gun and ammunition companies.

The demonstrations and looting in Portland, Ore.; New York City; and elsewhere have scared people. Ammunition, rifles, shotguns, and pistols are now hard to buy, according to numerous reports. Tactical gear like chest rigs that carry extra magazines and battle equipment are also hard to find.

We were early to recognize that 2020 would be an exceptional year for gun sales because so many people were afraid of civil unrest. In late April, we advised investors to bullishly trade Smith & Wesson Brands (ticker: SWBI) and Sturm Ruger (RGR), as the surge in gun sales wasn’t yet part of the national dialogue.

Now those fears have since become a major national story, and demand for guns and ammunition shows no signs of abating whether President Donald Trump or former Vice President Joe Biden wins the election. September was the sixth straight month of more than 50% year-over-year growth for federal background checks. It is time to reset our positions.

The usually moribund Smith & Wesson, Ruger, and Vista Outdoor (VSTO), which makes ammunition, are among the year’s best-performing stocks.

Our previous recommendation to buy Smith & Wesson’s September $10 call options when the stock was at $9—at the time, the company was called American Outdoor Brands—produced a return exceeding 100%. Smith & Wesson makes a popular, and not expensive, AR-15 rifle. (Calls give the buyer the right to buy the underlying asset at a set price within a specified period.)

The recommendation to buy Ruger’s October $55 calls when the stock was at $54.50 has also been profitable. We would recommend taking profits and not resetting the trades, if it weren’t for the continuing social anxiety about the future that seems likely to keep gun sales brisk.

Aggressive investors should focus on Smith & Wesson’s calls that expire in January and Vista’s calls that expire in February. Pick strike prices that equal or slightly exceed the stock price. The trades monetize the seemingly insatiable demand for AR rifles and ammunition.

Consider Smith & Wesson. The stock is up 135% so far this year. Shares are up 219% over the past year.

With the stock trading at $16.78, investors can buy Smith & Wesson’s January $17.50 call for $2.45. The trade will break even if the stock is above $19.95 at expiration. At $25, the call is worth $7.50. During the past 52 weeks, Smith & Wesson’s stock has ranged from $4.24 to $22.40.

Without a doubt, the suggested trade is extremely aggressive. In the options market, Smith & Wesson’s January $17.50 implied volatility is about 85%. This means that the market is pricing the stock as if it will move 5.3% each day until the option expires on Jan. 15.

Options volatility measures the options market’s expectations for how a stock will behave in the future. To contextualize Smith & Wesson’s options volatility, note that the implied volatility of the S&P 500 index is about 22%.

The discrepancy between the market benchmark and Smith & Wesson stock is significant, and it reinforces the red-hot nature of the stock.

Many investors prefer to sell options with elevated implied volatility as a way to monetize the fear or greed premiums in the options market, rather than paying top dollar to trade an option. Yet there are times when it makes sense to focus more on the stock and less on options dynamics.

Now is one of those times with Smith & Wesson—if one believes that the demand for gun stocks will show no sign of abating through the January expiration.

Originally Posted on October 16, 2020 – It’s a Golden Era for Gun Sales. Here’s How to Play It.

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