A Surprise in Retail
Source: Dick’s Sporting Goods.com
Analysts often believe they can forecast trends based on news events. This is especially true when the news is widely disseminated and seems as if it should affect revenue. This was the case with Dick’s Sporting Goods, Inc. (NYSE: DKS).
In response to recent mass shootings, the company announced that it decided to stop selling assault style weapons at its Field & Stream stores. (They weren’t sold at flagship Dick’s locations.). In February, when announcing the decision, Dick’s Chairman and CEO Edward Stack said:
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“We’re staunch supporters of the Second Amendment — I’m a gun owner myself. We don’t want to be a part of this story, and we have eliminated these guns permanently.”
The company also increased the minimum firearms purchase age to 21 and decided that it would no longer sell high capacity magazines and so-called bump stocks from all of its stores.
In a later interview, the longtime CEO said he believed the private sector can take a role in effecting change in the U.S. gun-control debate. He has been lobbying members of Congress and met with Everytown for Gun Safety, a gun-control advocacy group.
But, some manufacturers responded in a negative manager. “We don’t have the best relationship with the firearms manufacturers right now,” Dick’s Chief Financial Officer Lee Belitsky said.
Mossberg & Sons is a gun manufacturer that sold firearms to Dicks, and Belitsky isn’t too sure where the manufacturer might stand on giving Dick’s business. “Mossberg did indicate that they weren’t going to sell us on a direct basis,” Belitsky said.
Earlier this month, Dick’s was expelled from membership in the National Shooting Sports Foundation due to “conduct detrimental to the best interests” of the firearms trade association.
This all contributed to a negative perception. At least some analysts quickly jumped to the conclusion that this would result in lower sales and, therefore, the decision would hurt earnings.
Earnings Shatter Expectations
This week, Dick’s Sporting Goods posted higher quarterly profits and sales, according to reports, “allaying concerns that its controversial decision to tighten gun policies would dampen demand at the sporting-goods chain.”
The stock jumped on the news.
Same store sales declined 2.5% in the latest quarter compared with the same period a year ago. The decline was not unexpected. Dick’s CEO confirmed that the new gun restrictions had hurt traffic and sales at Dick’s, as customers unhappy with the moves said they would shop elsewhere.
The retailer said its hunting business suffered, but it reported better demand for other items, which helped profit margins. Dick’s said it relied on fewer promotions to move merchandise and was able to reduce its inventories.
Analysts polled by Consensus Metrix were expecting same store sales to drop 1.4%, so this metric was lower than expected.
Dick’s reported total sales of $1.91 billion, up 4.6%, helped by the opening of new stores and the conversion of stores that had been outlets of Sports Authority, which filed for bankruptcy. Dick’s operates more than 800 stores, including Golf Galaxy and Field & Stream locations.
Profit rose 3.2% to $60.1 million, or $0.59 per share. That was better than Wall Street expected, and the company raised its profit goals for the fiscal year.
Reaction was mixed. Despite the gain, analysts at Canaccord Genuity lowered their sales and earnings estimates for Dick’s, citing weakness in the hunting category as well as slowing demand for athletic apparel and certain sports categories. Fall is typically the busiest season for the hunting business.
This would be consistent with the stock’s long term down trend.
With a potential short term reversal, traders could buy the stock. But, many investors will be uncomfortable with high risk. Options strategies can address that concern.
Trading the Trend
When a stock is expected to move higher or pull back slightly, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.
Source: The Options Industry Council
This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call, which is to generate some income. This trade generates immediate income and carries limited risk.
A Specific Trade for DKS
For DKS, a bull put spread could be opened with the June 15 put options. This trade can be opened by selling the June 15 $35.50 put option for about $0.40 and buying the June 15 $34 put for about $0.10.
This trade would result in a credit of $0.30, or $30 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $1.50 ($35.50 – $34). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $120 ($150 – $30).
The potential gain is about 25% of the amount of capital risked. This trade will be for about two weeks and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider