Event: Michael Kors (KORS) reports fiscal Q3 results tomorrow before the open. The options market is implying about an 8% one day move tomorrow, which is basically in line with the average one day post earnings move of about 8.3%, and below the average of about 9% since going public in mid 2012.
Price Action / Technicals: The stock is down 4% year to date, down 30% from its 52 week high made in mid March, and down 60% from its all time highs made in April 2014. Taking a long term view since IPO, the chart is nothing short of a trainwreck, approaching key long term technical support at $40:
Taking a shorter term view though, it’s hard to not see the potential for a double bottom just above $40:
However, the same could have been said about shares of Ralph Lauren (RL) prior to their fiscal Q3 report on Thursday. The shares were down 12% that day, also down about 30% from its 52 week highs and also down about 60% from its all time highs made in 2012:
The high-end apparel space appears to be a disaster, which should not come as a surprise when you look at the performance of the department stores and the commentary regarding what’s selling and what’s not.
There have been some outliers, as Coach (COH) put up a decent Dec quarter last week (likely the result of lower than usual discounting) but offered worse than expected forward guidance. COH has been locked in a multi-year battle with KORS who has taken share. And let’s not forget Kate Spade, which has been nipping at their heels.
So what’s the trade?
For those already long KORS and worried about a large gap lower following weak guidance might consider a hedge, or replacing stock with defined a defined risk strategy. For those looking to be contrarian in a stock that trades about 9x earnings, where sentiment is horrible, 8% short interest, and only 4 Buy ratings, 23 holds and 1 sell, which may reflect near term bad news, it makes sense to define one’s risk to catch the bounce, but limiting losses on case the stock follows RL on a breakdown below support.
Hedge for existing longs/ Bearish
vs 100 shares of KORS (41.30) Buy the Fen 10th weekly 45 / 37.50 collar for 40 cents
- sell 1 Feb 10th weekly 45 call at 50 cents
- buy 1 March 37.50 put for 90 cents
Rationale – This hedge caps gains at 45 between now and this Friday, about in line with the implied earnings move to the upside, but protects against a decline below $37.50 (inline with the implied move) between now and March expiration. If the stock is above 45 after earnings the hedge will have capped the move but can be removed as a loss versus the gains in the stock. The idea about selling the call this week vs buying a longer dated put is that we don’t like the idea of capping gains for too long, but like COH last week, maybe the good news is short lived. While the choice to buy a longer dated put is simple, if the company disappoints, the stock is likely to be down 10% and who knows how low it could go over the coming weeks. The trade off with a collar is that you are giving up some potential upside to have defined protection to the downside for a stock that your own.
in lieu of 100 shares of KORS (41.30) Buy the Feb 10th weekly 41 / 46 / 51 Call Butterfly for $1.35
-Buy to open 1 Feb 10th 41 call for 2
-Sell to open 2 Feb 10th 46 calls at 35 cents each or 70 cents total
-Buy to open 1 Feb 10th 51 call for 5 cents
Break-Even on Feb 10th expiration:
Profits:up to 3.65 between 42.35 and 49.65 with max gain of 3.65 at 46
Losses: up to 1.35 between 41 and 42.35 & between 49.65 and 51 with max loss of 1.35 below 41 or above 51
Rationale: This defines risk to 1.35. That’s the most that can be lost on a gap lower, much less than the implied move in the stock. On the upside, this trade breaks even at 42.35, about a dollar higher than the stock right now so there is a chance the trade loses money on a small move higher. But it targets a bigger move higher, and any move above that breakeven is profitable. The mid point of 46 is above the implied move so the trade offers a wide range of profitability. The key though is the defined risk. If the stock declines like RL, the losses are limited.