This Company’s Good News Included Too Much Bad News
The headlines were clear before the stock market opened. CNBC and The Wall Street Journal reported that Macy’s (NYSE: M) had beaten earnings estimates.
Sales for the most recent quarter totaled $5.57 billion, down 1.1%, compared with net sales of $5.64 billion in the same three months of 2017. Analysts polled by FactSet Research Systems Inc. predicted $5.55 billion in sales.
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Earnings per diluted share also beat the consensus estimate — Macy’s reported EPS at 70 cents compared with an estimate of 50 cents.
Macy’s beat estimates in same-store sales: They came in up 0.5%, whereas consensus estimates predicted -0.5%.
The company also raised guidance for fiscal 2018 and now expects adjusted earnings per diluted share of $3.95 to $4.15, excluding anticipated settlement charges related to the company’s defined benefit plans as well as impairment and other costs.
The company expected total sales to range from flat to a 0.7% increase compared with 2017. Macy’s estimated comparable sales on an owned plus licensed basis would go up between 2% and 2.5% for the second half of 2018, which works out to a yearly upswing of 2.1% to 2.5%.
CEO comments were bullish, “Macy’s Inc. delivered strong performance in the first half of the year, and we are pleased to report our third consecutive quarter of comparable sales growth. Macy’s, Bloomingdale’s and Bluemercury all performed well.
It is encouraging to see the continued strengthening of our brick & mortar business, where we saw trend improvements across the portfolio, led by our Growth50 stores,” Macy’s chairman and CEO Jeff Gennette said in a statement.
“The combination of healthy stores, robust e-commerce and a great mobile experience is Macy’s recipe for success.”
But, All That Wasn’t Enough
But, the bullish news didn’t help much and the stock quickly plummeted by double digits when the market opened.
According to the TheStreet.com,
“While there are good reasons for the slowdown in sales growth, and although underlying performance is respectable, the decline in total sales and the virtually flat comparable numbers look bad. This is likely spooking some investors and has raised questions over how sustainable Macy’s recovery is,” Neil Saunders, managing director of GlobalData Retail, told TheStreet after the earnings call.
“There is also a sense that this was an easy period of trading thanks to a number of favorable economic factors and the view is that Macy’s has not fully capitalized on it.” Investors realize that Macy’s has a lot more work to do before it is back to full health. This means that they are not as willing to give the group the benefit of the doubt when growth slides. In addition to the above, there may be some sell-off after the share price inflation over the past three months.
Now, the question is whether or not the up trend in the stock is over.
It is likely that Macy’s will need time to recover. And, while the stock is recovering, there are strategies traders could use to benefit from the likely direction of the trend.
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.
A Bear Call Spread in MCHP
For M, we could sell a September 21 $37 call for about $1.25 and buy an September 21 $39 call for about $0.65. This trade generates a credit of $0.60, 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 $60. The credit received when the trade is opened, $60 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $140. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($60).
This trade offers a potential return of about 42% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if M is below $37 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 $140 for this trade in M.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.