Trade Update – $GRMN: Sold Put Diagonal for a Profit

by Enis October 2, 2014 10:52 am • Commentary

This morning, GRMN has broken the $50 support level that we had been watching:

GRMN daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg
GRMN daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

The stock’s break of that level sets up the possibility of a bigger move lower, as I detailed in my Considering Our Options post last week.  With GRMN now at $49, the trade is flat delta, and it will quickly become long delta on any further selling.  As a result, I’d rather take the profit today on this trade than risk giving up some of the gains if GRMN sells off more swiftly now that it has broken long-term support.

Action:  GRMN ($49.15) Sold to close the Jan15 52.5 / Oct 50 put diagonal at $3.74 for a $1.10 gain



New Trade – $GRMN: Recalculating

Garmin has struggled in the past two months as its competition has gotten more attention.  The stock is down about 14% from its early July high.  The GPRO IPO led to a drop in demand for GRMN shares as wearable enthusiasts moved on to the more exciting name (see my CotD post from 2 weeks ago).  Now, the Apple Watch is a potentially devastating competitor for Garmin products.

For the uninitiated, Garmin has steadily moved away from its automotive GPS roots into the wearables market, offering an array of consumer choices for fitness and outdoor enthusiasts.  The fitness and outdoor segments now make up about 35% of revenues, compared to 45% of revenues for the automotive segment (which is down from about 50% last year).  Management’s strategy is to focus on the high growth segments to make up for the 15-20% per annum decline in the GPS business.

For example, check out their myriad offerings in the fitness and outdoor segments at their site.  Here’s a taste:

Screen Shot 2014-09-17 at 8.15.55 AM

Management was proud of its growth in the wearables arena, highlighting its long-term commitment to the segment on the Q2 conference call:

The diversity of features, form factors and price points that are driving growth affirms our strategy of innovating across a broad portfolio of offerings. With that in mind, we continue to invest aggressively in fitness R&D, with the commitment to explore, develop and deliver superior products and services that our customers desire.

Unfortunately for Garmin, the value of Apple’s ecosystem is that app developers can very quickly add a plethora of functionality to the Apple Watch once it is released.  If the Watch is even modestly popular, a significant horde of developers will build in more functionality in one Apple Watch than most of the Garmin wearables combined.

Other watch competitors are already feeling the heat from the looming new entrant:

Swatch Group shares hit a new 52 week low today as investors are concerned about the impact of Apple competition.  From a TechCrunch article yesterday:

A source said that Swatch Group head Nicolas Hayek Jr., son of the late SG CEO Nicolas Hayek, is adamant that the company would not be pursuing smartwatches inside Swatch itself or within any of the many Swatch brands. The source said that Hayek Jr. felt “burned” by a 2004-2005 MSN SPOT watch partnership that fizzled and is avoiding mention of smart watches in general.

“He commented that he saw no future in these smart watches and that Swatch Group would stay out of it,” the source said.

Here is the 1 year chart of Swatch:

Swatch daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg
Swatch daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

I have been bearish on GRMN for the past 6 months because the stock’s valuation has expanded in the past 2 years even as the underlying business has not materially improved in my view.  The stock trades at a 17x P/E, with expected EPS growth of only 3% over the next two years.

I would much rather be the dominant leader in one growing category, as Garmin was in the GPS arena before the smartphone took over, rather than a hustling competitor in various growth categories, which is Garmin’s current situation in the wearables market.  Two-thirds of Garmin’s EPS still comes from the automotive GPS segment, where revenues are expected to continue to decline.

Apple’s entry into the wearables sector is simply the latest headwind for Garmin’s desperate hardware strategy. Management has actually done an admirable job of filling in the revenue gap from the decline in GPS use. Nonetheless, the long-term business prospects for Garmin are murky and difficult at best.

The upcoming 3-6 months will be telling in terms of Garmin’s ability to compete with the heavyweights, so here’s my trade:

TRADE:  GRMN ($53.36) Bought the Jan15 52.5 / Oct 50 put diagonal for $2.64

-Bought 1 Jan15 52.5 put for $3.18

-Sold 1 Oct 50 put at $0.54

TRADE RATIONALE:  At first, it looks nonsensical to buy a 2.50-dollar wide put spread for $2.64. But hear me out.  This is similar to the put calendar trades we do on the site (where you pay premium for a 0-dollar wide put spread), but I’ve staggered the strikes.  The ideal scenario is that GRMN ends October expiry at $50 (which is important support), at which point I will own the Jan15 52.5 put for $2.64 (close to parity) as the Oct 50 put expires worthless.

$50 is important near-term support for GRMN, and near the low from last week after the Apple Watch was first announced:

GRMN daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg
GRMN daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

Earnings will be after Oct expiration, so no major catalysts exist for GRMN between now and Oct expiration.  The main risk to this trade is a big move higher in GRMN, so we’ll be watching the $55-$56 resistance area closely in managing the position.