Name That Trade(s)- $M: Considering 2015 Guidance

by Dan February 6, 2015 2:32 pm • Commentary

Yesterday in my MorningWord (Retail Therapy) I discussed the investor push and pull for U.S. retailers between those with little to no exposure to a strong dollar that benefit from lower oil (both from the benefit to their consumers and lower input costs for the business) like Costco (COST) and Kohls (KSS) and on the flip-side, retailers like Ralph Lauren (RL) that saw the benefits of lower oil for their customers offset by the headwinds of a strong dollar as a little more than a third of their sales that come from outside the U.S.  I concluded:

So all retailers are not created equal in the lower oil / strong dollar environment, one that we could be in for a while. Domestic focused stocks seem like the place to be, but I would add that the smart money has been in this second derivative trade for a while, and chasing stocks like COST which trades at 30x expected 2015 expected earnings growth of 11% could be a hard way to play going forward.

A stock that might fit in between the COST and KSS , keeping with this theme of heavy U.S. domestic sales exposure, with little to no strong dollar impact, is Macy’s (M).  The company issued Q4 guidance earlier in the week, along with an acquisition and some management changes.  Morgan Stanley downgraded the stock to a Hold (read highlights here from Barron’s). Essentially, they think the stock is expensive to itself historically and the potential for a positive guide for 2015 could be in the stock at current levels as the company might have exhausted much of the benefits from recent cost cutting initiatives.   

The breakout this past week in 100% domestic used car and auto parts dealers AutoNation (AN) and O’Reilly Automotive (ORLY) got me thinking that 100% sales in the U.S. seems like the place to be. That led me back to Macy’s, which reports full Q4 on February 24th, and should give full year guidance.

From a technical standpoint, the stock broke out in January to new all time highs, but has since retreated:

[caption id="attachment_50721" align="aligncenter" width="600"]Macy's 1yr chart from Bloomberg Macy’s 1yr chart from Bloomberg[/caption]

The one year chart above points to what would be an ideal entry for the stock on the long side, and that is $60, which corresponds with the stock’s 200 day moving average (yellow line) and the low from December, before it mounted a 10% run to new highs.

Playing for breakouts is a tricky thing, it is one of the most powerful technical patterns that exists after long consolidations when confirmed by large volume.  I am going to give this idea some time to percolate. But If I were to put on a trade now to play for a post earnings breakout, I would rather look to define a range where I would be long on the upside and downside as opposed to buying the stock at current levels more than two weeks before the event.

Here are two trade ideas, the first is if I would be inclined to buy the stock right now, right here, but I am waiting for a better entry, and the second if I were inclined to play for a continued consolidation in and around $65 and I wanted to finance the purchase of near the money calls:

First – Directional:

Hypothetical Trade – Macy’s (M) $64 Buy the March 60 / 65 Risk Reversal for .75

-Sell to Open 1 March 60 put at .90

-Buy to Open 1 March 65 call for 1.65

Break-Even on March Expiration:

Profits: above 65.75, or up 2.7%

Losses: below 65 lose 75 cents, below 60 put the stock plus the loss of the 75 cents premium

Rationale:  While options prices are not exactly expensive, the sale of the put to finance the purchase of the upside call makes sense as opposed to buying the stock right here, which seems to be in no man’s land more than two weeks prior to the catalyst that could cause the breakout.  One reason I am not placing a trade now is that the stock has lost some momentum. It’s flat on a week that saw the XRT gain almost 3.5%.  Ideally I’d look for an entry closer to $60 support.


Second – Near Term Consolidation in front of Catalyst: 

Hypothetical Trade – Macy’s (M) $64 Buy the Feb / March 65 Call Calendar for 1.10

-Sell to Open 1 Feb 65 call at .55

-Buy to Open 1 March 65 call for 1.65

Break-Even on Feb Expiration:

Profits: max gains with stock in and around 65

Losses: significant move above or below 65

Rationale:  The idea here is the for the stock to close very near 65 on February expiration (in two weeks) at which point I’d look to cover the Feb 65 call, or have it expire worthless. Then I’d look to further reduce the premium at risk by spreading the March calls, or even turning into a risk reversal as discussed above.

Stay Tuned.