Regular readers of RiskReversal know that we’ve had a long going negative view on Macau gaming stocks and Wynn Resorts (WYNN) in particular (our list of posts here). My skepticism towards what seemed like universal bullishness regarding the U.S. casino operators in Macau started with a trip to the island in mid 2012, and continued in 2013 during the WYNN’s ramp higher, a move higher that was amid what appeared to be a dramatically cooling economy in China.
WYNN is down more than 50% from its 2015 highs, and shockingly down 31% in just the last month with very little company specific news, vs the Shanghai composite down about 13% in the same period.
The seven year chart (below) shows last month’s breakdown at long term support of $100, and then a free fall to what could be the next massive support area near $50:
Your guess is as good as mine where it bottoms. Just like oil it appears that there are some supply / demand elements in Macau gaming that seem out of whack and could take quarters, possibly years to work themselves out. And just as WYNN overshot to the upside in early 2014, it has the strong potential to do so on the downside.
In 2009 when the stock traded as low as $16, WYNN saw its earnings decline 90% year over year, from $2.51 to 26 cents, despite sales actually increasing 2% from 2008 to 2009 to $3.05 billion. Since 2009 WYNN saw a dramatic ramp in earnings to $7.58 a share in 2014, but now has an expected 58% decrease in 2015. The stock trades as if investors think that 2015 estimates are still way to high as the stock trades at 22x expected 2015 earnings.
As one would expect, options prices have spiked alongside volatility in Chinese and U.S. stocks, making directional long premium options strategies a difficult way to make money for those with a short term view, or those simply looking to pick a bottom.
For those who think shares of WYNN will bottom before economic data in China, and gaming data in Macau, it could make sense to use elevated options premiums to define a range in which you would get long both up or down on January expiration with minimal risk inside 30% in either direction. Yes that’s right… 30%.
But remember, the stock just dropped 30% in the past month and if there was ever a reason for shorts to cover, and investors looking for near pure China plays in the U.S. market, we could see the stock quickly make up some lost ground.
I am not yet there mentally to bottom pick, but if I wanted to mark a placeholder trade in the stock, and willing to be put the stock down 30% on January expiration (down 70% from its all time highs!) I would do it with a risk reversal. Here’s how to do it:
Hypothetical trade: WYNN ($72) Buy Jan16 50 /95 Risk Reversal for 15 cents
-Sell to open 1 Jan16 50 put at $2
-Buy to open 1 Jan16 95 call for $2.15
Break-Even on Jan16 expiration:
Profits: unlimited gains above 95
Losses: 15 cents between 50 and 95. put the stock at 50 or below and lose one for one.
Rationale: We will circle back on this idea and possibly adjust strikes and trade a similar structure if the stock were to test the mid $60s in the coming weeks. It is our view that sentiment on China will not turn on a dime, but it could for a stock like WYNN that has been out of favor for so long.