It’s been two weeks since athletic footwear and apparel retailer Foot Locker (FL) announced that it would sell itself to Dick’s Sporting Goods (DKS) for $2.5 billion, including the assumption of $100 million in net debt. 

Foot Locker was already in a downward spiral when CEO Mary Dillon, former CEO of Ulta Beauty (ULTA), was hired in August 2022. 

Between its five-year high of $66.71 on May 17, 2021, and its closing share price of $31.98 on Aug. 18, 2022, the day before Foot Locker’s announcement, FL stock lost 52% of its value over 15 months. 

Foot Locker’s board brought Dillon on board to reignite the retailer’s popularity with shoppers.

“Dillon is likely to focus on making Foot Locker stores more attractive to a range of shoppers, including ‘sneakerheads’ who are drawn to the design and cultural relevance of shoes, rather than just their utility,” Bloomberg reported on her hiring in 2022.

By the announcement of Foot Locker’s sale to Dick’s, FL stock had lost another 60% of its value. The $24-per-share offer boosted its share price by 85% in a single day. Since then, it’s traded very close to the sale price. 

Yesterday, there were 645 unusually active call options. Foot Locker had one of them. Consider the pros and cons of doing a covered call on the option.

The Option in the Spotlight 

The Dec. 18/2026 $20 call expires in 570 days, or 1.6 years. Yesterday’s volume of 934 was 2.57 times its Vol/OI (Volume to Open Interest), which isn’t massive volume, but enough to make the cut at 1.24 times OI or greater. 

A covered call occurs when you sell a call option on a stock you already own for premium income. Ideally, you want the share price at expiration to be OTM (out of the money), trading below the strike price. 

In this situation, the call is 19.5% in the money. Something closer to being ITM (in the money) or OTM (out of the money) is more ideal because you don’t want the call exercised by the buyer, forcing you to sell your 100 shares at $20, well below the share price, and in ther instance, the acquisition price per share.

The Cons of the Covered Call

The most obvious problem is that the exercise date is 569 days from now, well after the sale is expected to be completed in Q2 2025, just over a month away. So, soon. 

What happens in the situation where the company is acquired before the expiration date?

In this example, the expiration date is adjusted to coincide with the completion date of the acquisition. If things remain as is, the covered call is exercised by the buyer, and you are required to sell the Foot Locker shares at the strike price. 

If it’s a cash acquisition, the call could be settled in cash, resulting in you paying $4 per share ($400), the difference between the offer price ($24) and the strike price ($20). 

The good news is that you get to keep the $4.20 premium for a small profit ($0.20, or $20) on the trade. 

The Pros of the Covered Call

While this doesn’t seem like a great outcome, it depends on the price paid for the 100 shares you owned. 

For example, if you bought 100 shares at their low in mid-April, around $11.00, your total return would be $11.20 (102%), despite the covered call exercise, which involves the following components: [$20 strike price - $24 share price + $4.20 bid price (premium income) + $11 purchase price]. 

Based on a 2.5-month hold, which assumes a June 30 closing, that’s an annualized return of 496% [102% return * 365 / 75].

Not too shabby. 

The Deal Completion Risk

There is another positive aspect to this seemingly risky covered call strategy: Regulatory uncertainty and shareholder remorse. 

In the two weeks since Dick’s announced the sale, its shares have lost more than 10% of their value, as analysts worry about the risks associated with such a significant acquisition in a vastly different market than where the sporting goods retailer operates. 

“‘Retail integrations tend to be challenging,’ the UBS analysts said in a research note on Thursday. ‘There’s a far longer list of retail mergers that were not successful than those that were,’” MarketWatch reported. 

While it’s unlikely, Foot Locker could receive a higher offer from another company. In this instance, it would have to pay a $59 million termination fee. 

Conversely, Dick’s shareholders could decide that the risks associated with Foot Locker’s business don’t warrant spending $2.5 billion to acquire it. It would have to pay a $95 million termination fee for withdrawing its offer. 

Of course, Executive Chairman and founder Ed Stack holds 47.4% of Dick’s voting power. It will be tough to overrule his control of the company. 

The deal is more likely to die if the FTC (Federal Trade Commission) rejects the merger of the two companies, as it would result in too much market dominance in the hands of the combined entity, as was the case with Tapestry (TPR) and Capri Holdings (CPRI) in April 2024. 

The Bottom Line

As I mentioned earlier, if you purchased Foot Locker stock in the low $10s earlier in the spring, before the deal was announced, covered calls were a good idea to generate income. 

After all, its share price hadn’t been this low since Dec. 2009. Despite its troubles, it remains a big seller of sneakers. 

However, to sell calls at the $20 strike when the shares are nearly $4 higher, the risk/reward proposition isn’t worth it. 

You’d be better off buying a put slightly below the $24 sale price, as the cost would be minimal—say, $20 or $30—where you’d benefit significantly if the deal falls apart. 

On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.