Update Aug 9th, 2012 at 1:21pm: We looked at a handful of different trades and decided not to pull the trigger on any as we just don’t have strong enough conviction either way, but wanted to take the opportunity to lay out the structures we considered, and lay out what we liked and didn’t like about them.
Dan: 1st Trade Considered: Buy JWN ($55.35) Aug 52.50 / 50 Put Spread for .27, what I liked about this trade was that you were essentially making a 10 to 1 bet that the stock would be down 10% in 6 trading days that included their earnings announcement. Not bad odds, but the options market is suggesting that you only have a 20% chance that the Aug 52.5 Puts are in the money on next Friday’s expiration. So to make money on this trade not only do u need to get the direction right, but you need an out sized move followed by continued weakness. Given JWN’s correlation to Macys, and Macy’s results yesterday this may be a low probability bet for a good reason.
Dan: 2nd Trade Considered: Buy JWN ($55.35) Oct 52.50 / 48 Put Spread for 1.00, there is a few things that I like about this trade, first that the break-even is within striking distance of the implied move just for this week’s earnings, yet I have more than 2 months to earn it out. If the stock does not have a significant move higher on earnings this spread should carry decently as the strike that I am long is fairly close to the money, and after earnings there will be 2 other events in early Sept and Oct (monthly comps). Also paying $1 to make $3.50 if the stock is down 14% in 2 months back towards its recent lows is not horrible risk/reward.
Enis: 1st Trade Considered: JWN ($55.35) Selling the Sept 57.5 / 60 call spread at 0.63, The implied vol is just too low in JWN to justify short premium spreads when the stock is this close to highs of the year. While I don’t think JWN will break 57.5, if it did, and I was short this spread, I’d be in a cold sweat. It’s not worth the 0.63 in premium that you’d collect.
Enis: 2nd Trade Considered: JWN ($55.35) Buying the Jan13 50 / 40 1×2 put spread for 1.00, The attractiveness of this spread is 2 fold. One, there is not much delta or volatility exposure at initiation today, so it is a low-risk way to participate on a miss on earnings without losing much on the spread if the stock either doesn’t move or moves higher and volatility moves lower in the front months. Two, it gives you 5 months to maturity, so it is a much easier position to manage going forward if the stars don’t align on the post-earnings move tomorrow. The downside of course is the margin requirement for this type of position since you are exposed to being long the stock below $30. For those concerned about that, you could buy the Jan13 30 put for around 0.25, increasing your total cost to 1.25 and making this a put butterfly. I decided against this trade because despite all its advantages, the one disadvantage is that it won’t be that profitable unless it’s a big down move tomorrow, so I’d rather wait given that JWN has not moved more than 7% on earnings on any quarter in the last 3 years.
We hope that helps readers get a sense for our thought process behind not only the qualitative inputs we use to evaluate a story, but also how we arrive at the proper trade structure to express the view.
Original Post Aug 9th, 2012 at 1:21pm: JWN Q2 Preview and Thoughts
Event: JWN is set to report their Q2 earnings after the close tonight. The options market is implying a 5% move following the report, close to their 8 qtr average of 4.5%. Interestingly, the stock has sold off on 6 of the last 8 reports, even though it has actually beat estimates on 6 of the last 8 reports.
Sentiment: JWN is rated with 15 buys, 9 holds, and 2 sells among the 26 analysts that cover the stock. The average 12 month price target is 57.55, relatively low relative to current spot of 55.25. Short interest is 3% of float.
Price Action: JWN has mirrored the market’s move relatively closely over the course of this year, rallying until April, selling off hard in May, and now back near the highs of the year, up 11% in 2012. In fact, JWN’s correlation to the consumer discretionary sector as a whole has been quite strong, exhibiting between 60 and 90% correlation over the past 3 years. However, ever since its weak earnings report in May, the stock has been on the lower end of that 3 year range, between 60 and 70% correlated to the broader sector.
Technicals: The stock is less than 10% away from its all-time high set in 2007 at $59.70. Its intraday high for 2012 was on May 3rd, at 57.75, and its intraday low was set on June 5th, at 46.27. Looking at a much longer time frame, the 20 year chart shows a potential double top pattern forming if the stock holds below the 60 level:
Here is the 3 year chart to get a sense for the bull market uptrend:
The $46-$48 range is the clear support, with $57.5, this year’s high, as natural resistance.
Fundamentals/Valuation: This is a 17 P/E name with a 2% dividend yield, with forward earnings growth projections of 10-15% over the next 2 years. It is a purely domestic retailer, getting 100% of its revenues from the U.S. This is a pure play, high-end American department store, operating 231 stores in 31 states.
Consensus earnings estimate is 0.74, with a consensus revenue estimate of $3.01 bln. When the company missed estimates in May, and guided lower, it did say that it expected 2nd half gross margins to improve relative to the 1st half of the year, so there is some expectation of improvement here.
Volatility:
August ATM options are about 40 vol, which is high for recent months, but low for some of the craziness the stock has shown in the past few years. Here’s a look at vol in the stock the past 2 years:
The red line is implied vol across all months, blue the actual vol of the stock, and yellow the yearly average of implied vol. This stock is capable of big upward swings in vol during uncertain times, and then low vol during rallies.
The ATM straddle in August is about 2.65 at 40 vol. Depending on the move in the stock, that is likely to drop 10-15 points tomorrow morning. September ATM vol is 30 and would likely only fall into the mid 20’s following earnings.
MY VIEW: Based on commentary from a broad swath of consumer products companies in the U.S., it’s hard to see JWN delivering a blowout quarter. However, they are facing their own lowered expectations after lowered guidance in May, and the same store sales number on August 2nd was better than expected, indicating some improvement over the course of the summer. But it’s hard to see this stock breaking out on the upside given the tepid overall backdrop. With the stock only 4% from 5 year highs, the risk/reward seems especially tilted to the downside.
We are evaluating a few different trades in a couple different expirations, we will back if anything looks that compelling.