On November 17th TJ Maxx (TJX) reported Q3 results that pleased investors. The stock had been down in sympathy with its retail peers into the event but investors seem to be placing TJ Maxx in a different category than department store stocks like Macy’s (M) & Nordstom (JWN) with TJX now back up on the year while most other retailers hover at 52 week lows.
Into the event we detailed a couple of trades, one as a hedge against long shares and the other as a stock replacement/alternative for those that wanted to own the name after the sell-off but wanted to define risk in case the stock sold off hard on earnings like other retailers. The hedge was a Dec put fly that cost 2.30 and is basically worthless here. The stock is higher, more than the 2.30 in premium for the hedge, so in a sense it worked. In hindsight the 2.30 was probably too much to sacrifice but at the time implied vol was high and actual vol among retailers was massive so I’m not sure a cheaper and tighter hedge would have looked safe enough before the report. On that hedge vs long stock, nothing needs to be done here, the net trade is profitable and you still own the stock higher and were hedged into an uncertain event. But this may be the point where you start to look to overwrite upside calls in no earnings months to make up for some of the premium lost on hedges. Perhaps selling an upside Jan call on any strength.
The other trade is the one I want to detail as it needs to be managed with December expiration approaching. Here was the trade and rationale:
TJX ($64.40) Buy the Dec 65/70/75 call fly for $1
Rationale – Recent history has shown that investors are shooting first and asking questions later in the retail space, especially after earnings misses and guide downs. This trade reduces the downside risk to $1 and targets a realistic move to the upside if TJX has been able to avoid some of the inventory issues we’ve seen from other stores. The risk to the upside is a move substantially higher than $70 where profits begin to trail off, but the stock probably finds sellers above that area. Additionally since this is December, profits to the upside won’t be realized immediately so this is reducing deltas substantially in order to define your risk. So it’s not an earnings play that will pay off immediately like stock to the upside. It will take a few weeks to realize all those profits if the stock was near 70.
In the rationale we describe why one would do this trade in lieu of stock (reduce risk to $1) while also describing the sacrifice involved (profits on a move higher aren’t immediately realized until closer to expiration). But now we’re a couple of weeks out and the stock is exactly where this trade targeted but there’s still two weeks until it expires. So let’s look at how to manage this.
With the stock at 70.00 the call fly is worth about 2.50. That’s nice and more than a double on the initial risk but it still lags in comparison to the stock being more than $5 higher. If the stock closed at 70 on expiration (Dec 18th) this would be worth 5, so there’s 2.50 in short premium yet to be realized. The best way to think about that is you essentially have 2.50 in a stock move in either direction leading into Dec expiration that is your buffer zone. Anything inside of that for the stock and you make more that you have so far. Any move outside of that and the 1.50 in profit (unrealized) is at risk. So those are your mental stops. Now of course, it’s not expiration yet so a move in either direction immediately affects the mark to market value of the position. But time is on your side as the decay (the short premium collected) will begin to accelerate over the next 2 weeks. Right now the position collects about 5c a day (assuming no stock or implied vol moves). That 5c will rise each day as the Dec 70s’ decay picks up steam.
So basically patience is still in order. When you have a position on like this the longer you wait the better and your only trade management is keeping an eye on the stock and making sure it doesn’t drift towards your mental stops of 67.50 or 72.50 too fast.
Overall this trade is working and is a great stock alternative position into a risky event. But it does require patience.