Name That Trade -$GPS: Money Ain’t Got No Owners, Only Spenders

by Dan February 26, 2015 1:20 pm • Commentary

Gap Stores (GPS) reports their Q4 results tonight after the close, the options market is implying a one day move* of about 4.3% which is rich to the 4 qtr avg move of 2.5% and the 4 qtr avg of about 2%.

* With the stock at $40 the Feb 27th weekly (tomorrow expiration) 40 straddle (the call premium + the put premium) is offered at about 1.75, if you bought that you would need a move above $41.75 or below $38.25 to break-even on tomorrow’s close, or about 4.3%.

It is important to note that back in October the company announced the abrupt departure of their long time CEO, which caused a 12.5% one day decline in the shares, that was also the result of disappointing back to school same store sales.  The new CEO took over on Feb 1st, immediately issuing a same store sales miss for January, but raised the full year profit outlook on what looks like a lower tax rate.  

So for you traders out there, the stock is going to trade on forward guidance.  The new CEO, Art Peck has been with GPS for ten years, so it’s less likely that he would take a page out of the normal “incoming CEO playbook” and lower the bar to set the stage of a series of beats out of the gate. The reason is a downgrade of guidance would also be a reflection on his tenure as the President of Growth and Innovation for the last 3 years.

Price Action / Technicals:  The stock has been an under-performer for the better part of the last two years, down 5% on the year, and trading within a fairly wide range between $36 and $44 for the better part of this period, with the stock now in the dead middle:

[caption id="attachment_51365" align="aligncenter" width="600"]GPS 2yr chart from Bloomberg GPS 2yr chart from Bloomberg[/caption]

Implied volatility is not extraordinarily high going in:

[caption id="attachment_51378" align="aligncenter" width="627"]Screen Shot 2015-02-26 at 10.36.37 AM 2 yr IV30 from LiveVol Pro[/caption]

But March vol at about 32 right now will likely be in the mid to low 20’s following. That means a likely .50 decrease in the March at-the-money straddle overnight given no movement in the stock.

Teen apparel stocks have been a bit of a mixed bag of late with ANF in a death spiral and a bit of a resurgence by URBN. GPS is most definitely in a transitional period with a new CEO, with high expectations for a re-acceleration of growth.

Potential trades depending on your directional inclination:

Bullish:  For those who think management guides in line or higher and the stock retraces a bit of the recent decline, then the GPS ($40.22) March 40/42.50/45 call butterfly for .75  looks like a better own than stock. The spread is 22 cents in the money,  has gains of up to 1.75 between 40.75 and 44.25 with a max gain of 1.75 at 42.50.  Max losses of 75 cents below 40 and above 45.



Bearish:  If you are of the mindset that the new CEO lowers the bar going forward and the stock has risk back to the mid to high $30s, then I would look at the weeklies to merely isolate tonight’s earnings event.  With the stock at $40.30, the Feb27th weekly 40/38 put spread for 60 cents looks decent, break-even at 39.40, with max gain of 1.40 at 38 or lower.

The stock is right in the middle of the recent range, and taking a guess on guidance given the recent turn of events at the company does not seem like a great use of risk capital, but the set up is interesting for those who have conviction.