Domestic $TGT

by Dan June 28, 2016 10:54 am • Commentary• Trade Ideas

Earlier I offered some updated thoughts on the current investment environment (MorningWord 6/28/16: Eyes Wide Shut). In summary, I’m less than sanguine for U.S. stocks. That has been my view since the start of 2015. But that doesn’t mean there’s nothing to buy. During this sideways time period in U.S. stocks, we have expressed long biased views in defensive names like U.S. Telcos AT&T & Verizon, U.S. Utilities via the XLU and pharma stocks like Pfizer (PFE).  At this point we think domestic yielders like the ones listed above have become crowded.  Yes, they may continue to work if U.S. Treasury yields continue on their long race to zero, but at some point it makes sense to broaden out the search. There are other stocks with little exposure to the strength of the dollar overseas and that have a healthy dividend yield. Some of them have been beaten up and may be offering a great entry.

On such stock is Target (TGT). Despite scuttling their money draining Canadian operations in 2014, they still sport a dividend yield of 3.4%. And TGT trades at material discount to peer Walmart (WMT) and the SPX (TGT trades 13.4x expected f2016 eps growth of 9% vs WMT at 16.8x f2017 eps decline of 7%).

TGT has massively under-performed WMT in 2016, down about 3.5% ytd, down 16% from its 2016 highs made in mid April vs WMT up 17% year to date, and up 27% from its 52 week lows made last November.  TGT’s under-performance started with poor U.S. retail earnings and guidance in late February and was accentuated by their own weak Q2 guidance the company gave in mid May that saw caused an 11% gap lower.  The stock has been range-bound since between the lower end of the post earnings gap and is now breaking above the high-end at $70 with the possibility of a gap fill attempt in the offing:

[caption id="attachment_64678" align="aligncenter" width="600"]TGT ytd from Bloomberg TGT ytd from Bloomberg[/caption]

$75 is an obvious target in the near term. It’s also the stock’s 200 day moving average.  The next identifiable catalyst for TGT will be the company’s Q2 results They should fall in August expiration.

Short dated options prices look fairly reasonable with 30 day at the money implied volatility about 21%, well below the May lows of 28% and the 52 week highs made in February of 39%. August at the money vol is only about 23%:

[caption id="attachment_64679" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

I want to isolate TGT’s Q2 results as a beat and raise of the already lowered expectations could be the catalyst for a gap fill and a move back to $75.

So what’s the trade?

We’re going to use the upcoming long Holiday weekend as an opportunity to finance an August at the money call. We’ll sell a slightly higher July 8th weekly call and if that expires worthless, continue to roll to further reduce the cost of the August call:

*TGT ($70) Buy the July 8th weekly 72 / August 70 call diagonal  call calendar for $2.15
  • Sell to open 1 July 8th weekly 72 call at .25
  • Buy to open 1 August regular 70 call for 2.40

Break-evens/ Rationale – This trade does best if the stock creeps higher towards 72 in the next week and a half. If that is the case the the short call strike can be rolled, either keeping a calendar by selling a shorter dated call or establishing an August vertical that captures earnings by selling a higher strike call in August expiration.

-Risk exists of the stock goes significantly lower and if the stock were to gap higher above 72 before July 8th.

-The position starts at about 30 deltas but that will increase into July 8th if the stock is here or higher.