This Company Could Benefit from Problems at Sears
Problems often present opportunities. For investors, the question is how problems at Sears could present opportunities for profits.
Sears has been in business for 125 years but that could be coming to an end as reports indicate the company “is preparing a bankruptcy filing, proving that even the living dead can’t hang on forever.”
Sears hasn’t been profitable since 2010, yet Chief Executive Officer Eddie Lampert has kept it alive through clever financial maneuvering — shedding assets and even providing financial lifelines for the company via his hedge fund, ESL Investments.
The need to pay down debt left Sears even less able to reinvest in stores or e-commerce in a tough retail environment than other struggling mall-based stalwarts. Still, lenders have shown themselves willing to prop up retailers even when they are unprofitable.
Sears had been expected to survive through the holiday season but the company seems unable to meet a $134 million debt payment due this month.
Kohl’s Ignores the Woes of Its Sectors
Consumers will still shop somewhere, even after Sears is out of business. This could help competitors which include Kohl’s Corporation (NYSE: KSS).
Kohl’s has been in business since 1962 and in its latest regulatory filing the company noted that it operated 1,158 department stores; a Website Kohls.com; and 12 FILA outlets, and 4 Off-Aisle clearance centers.
The stock has been in an up trend for some time.
Recent market action has been bullish and the stock was recently pushed up by an upgrade to a ‘buy’ rating from Bank of America, which has a price target of $90 per share, representing about 24% upside from its current level.
CNBC personality Jim Cramer agrees that Kohl’s is a strong performer and shares of Kohl’s are in the portfolio of Cramer’s charitable trust.
Cramer said his trust has been upping his position in the stock because he expects Kohl’s to perform strongly this holiday season, with the added tailwinds of a strong job market and the Trump administration’s tax cuts.
The company has also rolled out a number of promising improvement initiatives, from smarter inventory management to its partnership with Amazon, which allows shoppers to return Amazon items at Kohl’s locations.
“The analysts are forecasting flat same e-store sales in the fourth quarter thanks to strong comparisons from last year, and the stock has now pulled back $11 bucks from its highs,” Cramer noted. “Call me a buyer.”
The stock appears to have tested support and could rally from here.
A Trade for Short Term Bulls
As with the ownership of any stock, buying KSS 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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for KSS
For KSS, the October 19 options allow a trader to gain exposure to the stock.
An October 19 $75 call option can be bought for about $0.70 and the October 19 $77.50 call could be sold for about $0.25. This trade would cost $0.45 to open, or $45 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 $45.
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 KSS the maximum gain is $2.05 ($77.50 – $75 = $2.50; $2.50 – $0.45 = $2.05). This represents $205 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $45 to open this trade.
That is a potential gain of about 455% 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.