Name That Trade: BBBY Edition

by Enis September 17, 2012 1:22 pm • Commentary

Event: BBBY reports fiscal Q2 earnings on Wednesday, Sept 19th after the close.  The implied move in the options market is only ~7%  (based on the Sept 70 straddle expiring on Friday),  despite the 17% drop in June following a weak number Q1 report.  The implied move is also shy of the 4 and 8 qtr average moves of 8% and 7% respectively.

Price Action: BBBY has been a high-flyer for most of the bull market, moving from below 20 to over 70 between 2009 and 2012.  It’s a 17 P/E company that has defied the general trend of box stores losing out to online retailers, maintaining a freshness to its offerings that other retailers have not been able to mimick.

My View on Vol: Looking at the options market ahead of Wednesday’s report, September weekly options don’t look particularly pumped.  However, October looks too cheap by comparison.  Why do I think October is too cheap?  

Here is the Option View of October options:


Scenarios: The Oct 65 / 75 strangle costs about $2.50, by comparison, the Sept 65 / 75 strangle costs $1.50.  So selling the Sept 65 / 75 strangle and buying the Oct 65 / 75 strangle costs about $1.00.

Let’s say BBBY is unchanged after earnings.  The Sept 65 / 75 strangle will be priced close to worthless.  Where will the Oct 65 / 75 strangle be priced?  This gets a bit complicated, but we can estimate how much the vol crush in Oct will affect the strangle pricing by assuming a certain move in implied vol for Oct options.  I think October options will move down about 8-9 vol points after earnings (based on the whole term structure and previous earnings moves).  In that case, the Oct 65 / 75 strangle (with the stock unchanged) would be worth around $1.25 – $1.50.

The main way the strangle calendar could lose money is if there is a very big move in Sept (similar to the 17% move from June), in which case there would be less than $1.00 of time value in the Oct options since they would both be far from the new spot value (one worthless, one worth close to the intrinsic value).

I think there is some recency bias to the pricing of the BBBY options in Sept vs. Oct, as market makers have the 17% move from June fresh in their mind.  So selling Sept and buying Oct sets up well here.