Name That Trade – $RH Into Earnings

by Enis March 24, 2015 1:10 pm • Commentary

Event: Restoration Hardware (RH) reports Thursday night after the close.  The options market is implying about a 8% one day move in either direction (based on Apr implied volatility at 46 and May implied volatility at 39).

Price Action / Technicals:  RH has tripled in the past 2 years, rising from around $30 to above $90 in a very steady fashion:

RH daily chart, 50 day ma in red, 200 day ma in blue, courtesy of LiveVolPro
RH daily chart, 50 day ma in red, 200 day ma in blue, courtesy of LiveVolPro

The stock broke out to a new high above $95 on the December earnings report, and has been relatively flat ever since.  However, the stock has held above the rising 200 day ma, which is now around $85.  The stock’s all-time high is $100.66.

Fundamentals:  RH has short interest of over 30%, and is a highly contested story.  While sales and gross profit have grown at a rapid 20-30% annual pace over the past 3 years, shorts point to the perpetually growing inventory as a sign of juiced earnings with negative cash flow.  One analyst probed CEO Gary Friedman about the inventory issue on the December earnings call, and Friedman answered as follows:

You can think about inventory turns and inventory optimization in a real vertical sense versus a horizontal model which is the model we’ve had, you know, to kind of get to where we are today as we’ve been trapped in these legacy stores, is, from a cash and return on investment point of view, because we’ve got a big capital workload, and an under-optimized investment in inventory, when we start growing vertically and we start using square footage, the model shifts. And then you start to get a model that will be highly optimized. And I would anticipate in the future that the inventory turns and the optimization to this model from, not just an inventory point of view but a cost point of view, will look very different in the future, which is reflected in the long-term potential of the company as Karen laid out in her presentation.

In other words, Friedman is explaining that the increase in inventories is simply a result of a larger, growing business, and that will normalize at some point in the future.  The shorts clearly don’t believe him, while the longs do.

As a result, it’s tough to say whether the 52x P/E and the $3.7 billion market cap is fair value or not.

Volatility SnapShot:  Implied and realized volatility in RH have gradually trended lower over the past 2 years.  That’s to be expected as the size of the company has increased, and investors have become more comfortable with the fundamental trends:

RH 30 day implied volatility in blue vs. 30 day realized volatility in red, courtesy of LiveVolPro
RH 30 day implied volatility in blue vs. 30 day realized volatility in red, courtesy of LiveVolPro

RH realized volatility over the past 6 months has averaged around 35.  In that context, 30 day implied volatility around 46 looks expensive going forward, indicating that options traders are expecting a big move (8-9%) on earnings.

Hypothetical Trades: Here are a few trade ideas into the print depending on your directional view:

(Note that they are all butterflies given the high level of implied volatility relative to realized volatility over the past 6 months, so be careful with bid/offer if you look to execute these trades.)

Bullish:   Apr 90/100/110 call fly for $3.20

This structure targets the all time highs with an in-the-money fly that reduces premium risk as much as possible.


Neutral: Apr 85/95/105 call fly for $2.80

This is playing for a range bound stock with a decent payout of the stock is unchanged to slightly higher following the event.


Bearish: Apr 90/80/70 put fly for $1.75

This structure looks for a possible break of the rising 200 day moving average with a defined risk trade. If you’re looking for pure protection, you can buy the Apr 90/80 put spread for around $2.40


We are not trading the name as we have no strong view in any direction.