New Trade JCP – Sentiment Way Too Bearish, Taking the Other Side

by Enis November 14, 2012 9:52 am • Commentary

Everyone’s jumped on the bash-JCP train over the past week.  Is JC Penney a broken story?  Yes.  Is it distressingly burning cash as it tries to turn around sales?  Yes.  Is CEO Ron Johnson running out of time before he’s fired?  Yes.  Even though it trades at book value, is its book value potentially overstated based on poor store locations?  Yes.  Does everyone already know all this?  Yes.

When I was on CNBC’s Halftime Report yesterday, the other traders were engaged in passionate attacks against JCP stock.  But JCP stock is down 50% from its mid-September highs.  50% drop in 2 months!  Surely, much of the bad news that each news outlet is trotting out has been digested by the market.  In fact, traders should always remember that for each buyer, there is a seller, and vice versa.  Meaning, there are people out there who must think JCP is a buy at current price levels, or it wouldn’t trade at current price levels.  I am finally one of those people.

Here’s an updated 5 year chart of JCP after the recent break of $19 support:

 

 

Clearly, the break of $19 was important.  My guess is the $19-20 area should serve as resistance on a bounce.  But with the stock so oversold (RSI of 18), and sentiment was negative, I think JCP very close to done going down.  I just think anyone who wanted to sell the stock has already sold.

One HUGE caveat here before I disclose my trade:  I think JCP offers a great trading opportunity through the options, but I have no bullish view on JCP’s long-term prospects, and wouldn’t buy the stock given the risks of catching a falling knife.  But sentiment is so washed out, I’m going to play for an improvement in sentiment with a nuanced trade structure.  

TRADE:  JCP ($17.55) Sold Jan13 19 straddle at $3.68, bought the Jan13 16 / 22 strangle for $1.51, collected $2.17 net credit on the structure

-Sold 1 Jan13 19 call at 1.10

-Sold 1 Jan13 19 put at 2.58

-Bought 1 Jan13 16 put at 1.06

-Bought 1 Jan13 22 call at 0.45

 

Break-Even On Jan13 Expiration:

-Profits if stock between 16.83 and 21.17 on Jan13 expiry, with max profit of $2.17 with stock at $19.00 on expiry

-Losses of up to $0.83 between 16.83 and 16, and 21.17 and 22, with max loss of $0.83 if stock below 16 or above 22 on Jan13 expiry

 

Trade Rationale:  My first instinct was to look for call spreads in JCP to play for a bounce.  But there were 2 problems with this approach:

  1. Implied volatility in JCP is quite high, so outright calls or call spreads are very expensive, offering poor risk/reward.  JCP has 40% short interest, so I did not want to do a 1×2 call spread (a la Dan’s AAPL trade) because JCP could easily rally 50% on a squeeze.
  2. JCP stock is very oversold.  In my experience, that’s usually just the START of the bottoming process for a stock, not the END of it.  That’s to say, even if JCP bounces from here, I expect it to chop up and down for a while in order to build a base for a longer-term rally.
Given those 2 conditions, playing for a range trade in JCP, with the mid-point 10% higher than current spot, is a structure that bets on a bounce in JCP, but puts time on my side if the stock does indeed chop around and build a base like I expect.  The structure also takes advantage of the high implied volatility by net collecting premium.  Finally, it offers me great risk/reward of close to 3 to 1, risking $0.83 to make $2.17.