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Bulls Might Finally Like Bed Bath & Beyond

Bulls Might Finally Like Bed Bath & Beyond

Trade summary: A bull call spread in Bed Bath & Beyond Inc. (Nasdaq: BBBY) using the November $21 call option which can be bought for about $2.45 and the November $26 call could be sold for about $0.95. This trade would cost $1.50 to open, or $150 since each contract covers 100 shares of stock.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $150. The maximum gain is $350 per contract. That is a potential gain of about 133% based on the amount risked in the trade.

Now, let’s look at the details.

Bloomberg reported “Bed Bath & Beyond Inc. shares soared to the highest level in more than two years after the home-goods chain posted a surprise gain in quarterly sales, a sign investors believe that turnaround efforts are paying off ahead of the holiday season.

Comparable-store sales, a key metric, rose 6% in the second quarter ended Aug. 29. Analysts had expected a decline of 1.3%, according to Consensus Metrix. Sales continued to increase last month, according to the company.

“We see things are taking hold and those green shoots that developed in the quarter are turning into trends in September,” Chief Executive Officer Mark Tritton said in a phone interview.

The company’s bonds also jumped. The 5.165% notes due 2044 rose more than eight cents to trade at 82.625 cents on the dollar for a yield of 6.6%, according to Trace bond trading data.

Revenue of $2.69 billion beat the average estimate from analysts, with e-commerce underpinning the improvement and offsetting a decline of in-store sales. Jonathan Matuszewski, an analyst at Jefferies, said Covid-related demand appeared to be the “overriding driver” of the performance.

As the critical holiday season approaches, the retailer is adding more services for consumers who may opt to continue shopping online. Earlier this week, it announced the start of same-day shipping and is also focused on getting popular kitchen items to customers quickly, Tritton said. Kitchen and college-related items have sold well, while luggage and travel goods haven’t, he added.

“Going into the holiday season, we think it’s still going to be around the home,” Tritton said. He anticipates that holiday sales will spread throughout the season, which helps avoid shipping strains.

Bed Bath & Beyond continues to pursue a multiyear revamp to shake off years of stagnation and decline.

Tritton is cutting costs and changing the chain’s focus to initiatives like curbside and in-store pickup for online orders. An improvement in gross margin, spurred in part by refocusing on more-profitable merchandise and the curbside initiative, indicates that the efforts are gaining steam.”

The daily chart shows that traders treated this as good news.

BBBY daily chart

The longer-term chart shows this breakout could run significantly higher before encountering resistance after a multiyear down trend. The chart shows a target neat $30 is possible.

BBBY weekly chart

A Specific Trade for BBBY

For BBBY, the November options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.

A November $21 call option can be bought for about $2.45 and the November $26 call could be sold for about $0.95. This trade would cost $1.50 to open, or $150 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 $150.

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 BBBY, the maximum gain is $350 ($26- $21= $5; 5- $1.50 = $3.50). This represents $350 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $150 to open this trade.

That is a potential gain of about 133% in BBBY based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

A Trade for Short Term Bulls

As with the ownership of any stock, buying BBBY 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 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 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.

bull call spread

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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.