About That Retail Apocalypse…Never Mind?
It wasn’t that long ago that news reports focused on the death of retail. There was no way, we were told, that traditional stores could withstand the efficiency of the Internet. Some analysts admitted this was also argued in the late 1990s, but this time was different they assured us.
This wave of retail bankruptcies would eliminate a large swath of retailers, but it seemed doubtful traditional retailers, especially department stores, could survive, according to many analysts. And, some focused on Sears and Macy’s (NYSE: M), as examples of an unsustainable business model.
Macy’s Tops Estimates
On Wednesday, Macy’s beat expectations for the most recent quarter and raised its full-year profit forecast. The company noted results were driven by strong international tourism spending, a new loyalty program and a greater assortment of products offered in stores.
“Tax cuts, bonuses and good tax refunds have all been a windfall to consumers who have responded by increasing spending,” said Neil Saunders, managing director of GlobalData Retail. “This rising tide has floated most retail boats, Macy’s among them.”
This marks a significant turnaround for the company which has closed more than 100 stores since 2015 and cut thousands of jobs.
Chief Executive Officer Jeff Gennette said on an earnings call the company saw double digit growth in its digital business and continued healthy consumer spending. It also had significant improvements in international tourism, which was up 10%, its best numbers since 2014.
“We have the digital growth obviously percolating and we are driving that very successfully,” Gennette said. “Brick-and-mortar needed a lot of work.”
Macy’s changed its loyalty program by opening it up to more shoppers and by offering free shipping and discounts to its highest spending customers.
Same store sales rose 4.2% in the quarter, topping expectations of 1.4% growth. This was the second straight quarter of same store sales growth which is a key metric of organic growth for retailers.
Looking ahead, Macy’s intends to open approximately 100 Backstage stores this year, 18 of which were opened in the first quarter while making it easier for shoppers to check out quickly using their mobile devices by improving its checkout technology.
The company said it now expects adjusted profit of $3.75 to $3.95 per share for the year, up from a prior forecast of $3.55 to $3.75.
It also forecast full year comparable sales at its owned plus licensed stores to rise between 1 percent and 2 percent. Analysts on average were expecting 0.3 percent growth, according to Thomson Reuters I/B/E/S.
“The quarter was good every month – in fact, every week,” Chief Financial Officer Karen Hoguet said on a call with analysts. “Spirits are up.”
The stock rallied on the news.
But, there is still significant upside potential after a steep multiyear decline.
A Trade for Short Term Bulls
As with the ownership of any stock, buying M could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for M
For M, the May 25 options allow a trader to gain exposure to the stock.
An May 25 $33.50 call option can be bought for about $0.85 and the May 25 $34.50 call could be sold for about $0.45. This trade would cost $0.40 to open, or $40 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $40.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in M the maximum gain is $0.60 ($34.50 – $33.50 = $1.00; $1.00 – $0.40 = $0.60). This represents $60 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $40 to open this trade.
That is a potential gain of about 150% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.