New Trade – $NKE: Doin It

by Dan June 25, 2015 11:22 am • Commentary

Event: Nike (NKE) reports their fiscal Q4 results tonight after the close. The options market is implying about a 3.5% one day move which is shy of the 4 qtr avg of about 4.5% (its important to note that there was a 12% gain 3 qtrs ago that has skewed the avg a bit, as the 3 other quarters avg was about 2.3%).  

Price Action / Technicals: NKE is up 9% year to date, dramatically outperforming the S&P 500 which is up only 2.5%, but lagging fitness apparel makers Under Armour (UA) up 25% and Lululemon (LULU) up 21% ytd.

The stock broke out about $100 to new all time highs on their Q3 beat back in March, and despite immediately given back all of the gains in the ensuing couple weeks, the stock has spent the better part of Q2 above $100:

[caption id="attachment_54815" align="aligncenter" width="600"]NKE 1yr chart from Bloomberg NKE 1yr chart from Bloomberg[/caption]

Over the last three years NKE has been in a very steady uptrend, making a series of higher highs and higher lows, up 150% from the 2012 lows:

[caption id="attachment_54816" align="aligncenter" width="600"]NKE 3yr chart from Bloomberg NKE 3yr chart from Bloomberg[/caption]

Implied Vol Snapshot:  While options prices (IV blue below) are lower into tonight’s print than they have been into the prior 3 quarters, it is important to note that realized vol (how much the stock has been moving, white below) is approaching 52 week lows, making long premium strategies look expensive:

[caption id="attachment_54817" align="aligncenter" width="600"]NKE 1yr chart of 30 day at the money IV (blue) vs Realized Vol (white) from Bloomberg NKE 1yr chart of 30 day at the money IV (blue) vs Realized Vol (white) from Bloomberg[/caption]

Valuation:  NKE is a premium brand with premium products, and rightfully so has always traded at a premium to the broad market and most of its apparel peers.  But with the stock just off of all time highs, and excepted earnings growth of 12% in fiscal 2016, and sales growth of 6%, the stock trading at 30x trailing earnings is a 10 year high, and at 26.5x forward may make the stock priced for perfection at current levels:

[caption id="attachment_54818" align="aligncenter" width="548"]NKE 20yr  P/E chart - Forward (green) and Trailing (brorwn) from Bloomberg NKE 20yr P/E chart – Forward (green) and Trailing (brorwn) from Bloomberg[/caption]

My View: As recently as early April I played for a breakout above $100 (here), but with the breakout happened, and the focus on their overseas exposure (specifically emerging markers where they are excepted to get much of their future growth) and near term headwinds from the strong dollar, I would expect to get conservative guidance for the balance of the year. The stock is priced to perfection in my opinion, and a pullback to $100 in the coming weeks could be in the cards.

Trade:  NKE ($105.35) Buy June 26th weekly 105/101/97 Put Fly for .95

-Buy to open 1 June26th weekly 105 put for 1.70

-Sell to open 2 June26th weekly 101 puts at .40 each or .80 total

-Buy to open 1 June26th weekly 97 put for .05

Break-Even on June26th weekly Expiration:

Profits: gains of up to 3.05 below 104.05 and above 97.95 with max gain at 101

Losses: losses of up to .95 above 104.05 and below 97.95 with max loss of .95 below 97 and above 105

Rationale: This trade targets a move back below the 50 day moving average with good risk reward but with options that will expire tomorrow. This last part means this trade is very binary and is a loser in 3 out of 4 scenarios (higher, flat, lower by a lot). But the risk reward reflects that (3 to 1) and we think the probability of a small move down versus those other scenarios are not all equal.

As always directional long premium strategies are challenged into events like earnings, as you need to get a lot of things right to merely break-even. In this example, if I get the direction wrong then the trade will be a total loss as I have just one trading day to be right.  But I like risking less than 1% in this instance as I think there is a lot of good news in the stock.