DKS in a Box

by riskreversal December 12, 2016 2:45 pm • Trade Ideas

Shares of Dick’s Sporting Goods (DKS) are down 4%, in a weak tape. While DKS price action does not exactly stick out like a sore thumb on an unusually weak day for retailers, with Macy’s (M). Nordstrom (JWN), Kohl’s (KSS) and Dillard’s (DDS) all down about 4%. But the put activity in DKS does warrant a second look.

When the stock was trading $58.11 shortly after 1pm it appears that a trader bought to open 10,000 of the March 48 puts for $1, or $1 million in premium. There are a couple things that stick out, first, with 14,000 of these puts have traded on the day, that make up about 40% of the entire options open interest coming into today (34,000 total).  These puts, if bought (they were reported to be, they traded on an uptick in price, and implied volatility in the strike also ticked up after the print) break-even on the downside at $47, down 19% from the trading level, just below the July breakout level:

[caption id="attachment_68869" align="aligncenter" width="600"]DKS 1yr chart from Bloomberg DKS 1yr chart from Bloomberg[/caption]

Without intimate knowledge of a trade its impossible to infer what any options trade might mean, without knowing if an outright directional bet, meant as a hedge, yield enhancement or leverage of an existing position, or possibly a trader taking a view on volatility.

In this case the options market is placing a little less than a 15% probability that these puts are in the money on March expiration, which does not make them a high probability bet if a directional view. If a hedge it might not exactly be the best use of a million premium, hedging 1 million shares.   It’s impossible to know, but sometimes this sort of flow can be helpful from judging sentiment. What if this was actually a bullish trade where someone positively disposed to the DKS story wanted to look for a put strike they were willing to sell where they would be a happy to get long the stock if put on a sharp pull back in the next three months? Either way, bought or sold, the choice of strike means that that level isn’t out of the question from either a bearish or room enough to feel safe for a sale/bullish standpoint.

Lastly, DKS is a company that many assumed would be all but out of business by now as one of the clear losers in big box retail wars with (AMZN). But the stock recently made a new all time high, after rallying nearly 80% from its Jan 2016 lows:

[caption id="attachment_68870" align="aligncenter" width="600"]DKS since 2002 from Bloomberg DKS since 2002 from Bloomberg[/caption]

DKS is not scheduled to report fiscal Q4 results until mid March, which might explain the choice of March expiration.

If we were inclined to make a near term bearish bet we would be more inclined to sell well out of the money puts to help finance higher strike near the money puts that have a higher probability of success. For instance, a quick gander of the one year chart shows near term support at $55, and and air-pocket down to about $50:

[caption id="attachment_68873" align="aligncenter" width="600"]DKS 1yr chart from Bloomberg DKS 1yr chart from Bloomberg[/caption]

Short dated options prices are below realized (the price of options vs how much the underlying stock is moving) possibly making options prices appear cheap to potential movement:

[caption id="attachment_68874" align="aligncenter" width="600"]DKS implied volatility vs realized volatility 1 yr chart from Bloomberg DKS implied volatility vs realized volatility 1 yr chart from Bloomberg[/caption]

Rather than looking for a break-even at $47 (vs stock at $57.80), I might be inclined to buy the March 57.50 / 48 put spread for $3, breaking even at $54.50, just below support and offering profit potential of up to $6.50 down to $48.  This put spread has a 30 delta, double that of the March 47s and breaks-even down 5.5% (rather than 19%).  Obviously this trade risks 3x the premium of the trade detailed above, but it is a matter of conviction and intent.

We thought a decent exercise to compare put strategies in a stock where any block trade like this outsizes the existing market.