Trade Update – $M: Bears on Parade

by Dan November 11, 2015 2:01 pm • Commentary

Back on Oct 30th we detailed a bullish long premium defined risk trade in Macy’s (M), after some call buying in the retail space got us thinking about contrarian targets:

The Macy’s out of the money call buy got me thinking of catalysts. Sentiment couldn’t be worse, despite its very cheap valuation (trading 11x fiscal 2017 expected eps growth of 11%.)  Earlier this year activist investor Starboard took a stake in the company and is pushing for a spin-out of their real estate holdings, which some investors think could be worth more than their existing market cap.   Early last year Macy’s management said 2015 would be an investment year, they bought Blue Mercury beauty stores and plan to open discount stores to compete with TJ Max. They’ve partnered with a retailer in Hong Kong to sell merchandise on Alibaba. They’re closing under-performing stores, pressing on in their omni-channel sales approach that includes online, and they’re in the midst of making real estate sales.  Management has been busy moving their feet, and investors seem to be discounting a lot with the stock down 22% on the year.

Here was the trade idea and rationale from Oct 30th:

M ($51) Buy Jan16 52.50 / 62.50 call spread for 2.50

Vol is high, but in this case we can look out to January expiration for a 3 to 1 potential payoff on a move higher that retraces about 50% of the stock’s 30% decline from its all time highs made in July. While options prices have reached levels not seen in years, this has happened as the stock has gotten hammered despite what we see as a ton of potential positive catalysts to move the stock substantially between now Jan expiration. Considering how poorly the stock has acted since July, call spreads appear to be a much better way to be long Macy’s from a risk reward standpoint if it turns out we are in fact trying to catch a falling knife.

Today Macy’s is down 15% after reporting disappointing sales, higher inventories and lowering their forward outlook. The stock is now nearing a 50% re-tracement from the move off of its 2008 lows to its highs this past summer, which is down another 10% near $36.50.  At $40, the stock is at fairly important support, with no real support till the mid $30s:

M 8 year chart from Bloomberg
M 8 year chart from Bloomberg

Our trade from Oct 30th is a total bust, and the long call portion is not worth selling due to commissions and can be viewed as a lottery ticket.


As far as catalysts are concerned, I have to assume that activists who have been involved see spinning out the company’s retail as that much more important now, with the strong likelihood that the stock’s 44% from its all time highs in July could attract new activists who see this markdown of a valued brand with value to be unlocked as attractive.

We were clearly wrong in even taking a shot. Us and others were not exactly expecting improved fundamentals in the near term, but the risk reward of the defined risk long premium trade in felt a lot safer than taking any serious downside risk in a beaten up stock.

To recap, when the stock was $51, we risked 5% of the stock price to possibly make 15% with nearly 3 months for the trade to play out.  Now with the stock down 21% from the trade initiation, the 5% premium outlay is nearly worthless, but it certainly beats the 21% decline.  The other lesson here is that when trying to catch a falling knife, it sometimes make sense to pay up in premium terms in an effort to manage risk, which is also what we did.

There is no way of sugarcoating this, it is a full blown disaster and I was wrong.  If you are like me, and honest about your trading, then you realize that you will have losing trades, and that you take solace in the fact that you went into the trade with an eye towards risk management.

If I were inclined to double down, or replace a long with the stock at $40 I would buy the Feb 40/50 call spread for $2.50. Risking 2.50 to make up to $7.50 if the stock is $50 or higher, up 25% on Feb expiration in 3 months. I am not trading it anew and just glad I defined my risk when clearly wrong.