Generate Max Income from TJ Maxx
Trade summary: A bear call spread in TJX, Inc. (Nasdaq: TJX) using September $52.50 call options for about $3.22 and buy a September $55 call for about $1.85. This trade generates a credit of $1.37, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $113. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($137). This trade offers a potential return of about 121% of the amount risked.
Now, let’s look at the details.
Investors sent stock in TJX Cos. lower after the discount retailer announced its latest quarterly results.
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According to Barron’s, TJX said it lost $214.2 million, or 18 cents a share, down from a profit of 62 cents a share in the year-ago period. Revenue fell by almost 32%, to $6.67 billion. Analysts were looking for the company, the parent of TJ Maxx, to break even with revenue of $6.55 billion.
As a nonessential retailer, TJX has seen a number of its locations shut by the pandemic. Its bricks-and-mortar shops were open for about two-thirds of the period. Sales at stores open at least a year fell 3%.
The company didn’t provide financial forecasts, given the pandemic, but it did say that traffic and sales moderated as it moved into the third quarter, as some areas of the country saw a jump in Covid-19 cases.
TJX said it expects comparable-store sales, counting only shops that are open, to be down by between 10% and 20% for the current quarter, in line with trends since mid-July.
Markets have given less leeway to nonessential retailers during the pandemic, as few have been able to offset bricks-and-mortar closures with online sales. That is doubly true for the off-price sector, which has limited, if any, online presence.
Yet it is likely too soon to count the stock out. While the shares will continue to struggle as the crisis drags on, the off-price sector has been a retail success story for years, and as Barron’s has noted before, it will likely outlive the pandemic’s threat.
Not only have traffic trends shown that customers are eager to return to stores when they can, but the company’s off-mall locations and strong value proposition are key advantages in the current environment.
“TJX’s short-term results belie long-term share opportunity to be had amid department store dislocation and we continue to see TJX as a long-term winner,” writes BMO Capital Markets analyst Simeon Siegel, “despite our belief that the second half of 2020 should still prove less than optimal between lighter traffic and inventory.”
MKM Partners analyst Roxanne Meyer writes that “the best time to buy TJX is on a macro dip or when the company faces a short-term internal execution issue,” as happened in this quarter. She said she is confident it will overcome this latest hiccup.
That isn’t to say that the shares will bounce back immediately: Without a vaccine or treatment, the Covid crisis will not only keep many shoppers at home, but continue to hurt the economy, reducing consumers’ spending power. While more government assistance would ease that situation, Congress hasn’t yet been able to act.
TJX has struggled to move back to its old highs even as the broad market recovered. The stock faced resistance and could now sell off more.
Shorting shares of the stock exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.
A Specific Trade for TJX
For TJX, we could sell a September $52.50 call for about $3.22 and buy a September $55 call for about $1.85. This trade generates a credit of $1.37, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $137. The credit received when the trade is opened, $137 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $113. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($137).
This trade offers a potential return of about 121% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if TJX is below $52.50 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $113 for this trade in TJX.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.