Trade Idea – $TGT Practice

by Dan November 17, 2015 12:13 pm • Commentary

Event: Target (TGT) reports Q3 results tomorrow before the open. The options market is implying about a 5.5% one day move, which is rich to the 4 qtr avg of only 2.25% and the 10 year average of about 2.5%.

Price Action / Technicals: Since making a new all time high in late June, TGT has declined about 15%, having made a series of lower highs and lower lows, with the stock on Friday making a new 2015 low, below its August 24th flash-crash low, before today’s bounce in sympathy with Walmart’s results.  TGT is down 2.6% on the year, vs WMT, down 30% on the year.

In the very near term, $70 should serve as important technical support on the downside, the level the stock gapped to following their Q3 results last November, with little support to the mid $60s. TGT should find some resistance at the prior high from Nov 4th just below $79:

TGT 2yr chart from Bloomberg
TGT 2yr chart from Bloomberg

Implied Volatility Snapshot / Open Interest:  As is the case with most other retailers, short dated options prices in TGT has risen above levels seen during August’s market swoon, and is now at multi-year highs:

TGT 2yr chart of 30 day at the money implied vol from Bloomberg
TGT 2yr chart of 30 day at the money implied vol from Bloomberg

Total options open interest is fairly even with 170k calls to 199k puts, with the largest near the money strikes all puts, with 12k of the Jan16 65 puts, 11k Jan 60 puts, 10k of the Dec 65 puts and 10k of the Jan16 75 puts.

On Friday there was a bullish options trade when the stock was $72.50, where a trader sold to open 2k of the Nov 67.50 puts at 90 cents, and bought to open 2k of the Nov 72 / 75.50 call spread for 1.65, with the whole package resulting in a 75 debit.  This trade breaks-even on the upside at $72.75, has gains of up to $2.75 between $72 and $75.50, losses of 75 cents between 72 and 67.50 and losses as if long the stock below $67.50 on Friday’s close in addition to the premium paid.

My Take:  

TGT trades 15.5x current year’s eps that is expected to grow 10%, and 14x next year’s eps expected to also grow 10%.  TGT’s PE is at a slight premium to peer target, a massive discount to Costco, and below the S&P 500.  With a 3% dividend yield, and an existing $10 billion share repurchase program, the stock screens as cheap.  If the company can report inline to consensus and merely guide inline, the stock should at the minimum hold its ground and possibly work higher into the holiday selling season.  Short dated options prices are obviously elevated, making long premium directional trades challenged, which is why we would look to trade structures like Butterflies or at the minimum a spread for those looking to express a directional view into the print.

Here are couple ways we would look to play depending upon ones directional inclination:

Bullish Trade Idea: In lieu of long stock into earnings.

TGT ($73.50) Buy the December 72.5/80/87.5 call fly for 2.40
  • Buy 1 Dec 72.5 call for 3.50
  • Sell 2 Dec 80 calls at .60 (1.20 total)
  • Buy 1 Dec 87.5 call for .10

Rationale – This trade breaks even at 74.90, higher than where the stock is currently trading but with implied vol so high the fly is the only way to define risk while lowering that break even to the lowest possible point (out of the money trades have higher break-evens) If the stock is higher after results, implied Vol should come in at least 30% and as much as 50% meaning the fly will realize much of its value if it’s above its break-even. The risk on this trade is a move lower where it the trade will lose much of its value. But it does define risk and protects against any move below 70.10 where there are no further losses below.


Bearish Trade Idea:  If you are of the mindset that TGT will guide the out year down, the way WMT did last month, and its stock will decline in line with the percentage eps downgrade, then this trade could serve as a hedge to long stock, or simply an outright bearish bet:

TGT ($73.50) Buy the November 72.5/67.5 put spread for 1.05
  • Buy 1 Nov 72.5 put for 1.55
  • Sell 1 Nov 67.5 put at .50

Rationale – This trade is about 4-1 in potential payout and for those that are long provides some peace of mind while keeping unlimited upside. The break-even is 71.45 and 1 to 100 shares provides unlimited protection below that.