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Trading options contracts is a low-cost way to profit from a company’s earnings announcement. Earnings reports have led to some big market movers in the past few weeks. After finding some profitable plays in Facebook (NASDAQ: FB), Green Mountain Coffee Roasters (NASDAQ: GMCR) and Monster Beverage (NASDAQ: MNST) in the past few weeks, I have another earnings play this week, and I think we could see a triple-digit gain on this one.
Sears Holding Corp. (NASDAQ: SHLD) is one of the oldest companies in the country, but its status has faded over time. Investors, however, want to love the company, probably because of the great reputation of its chairman, Edward Lampert, who is also a billionaire hedge fund manager.
Various turnaround strategies have failed to deliver profits as consumers have shied away from these once-great stores. And with earnings scheduled to be reported before the open on Thursday, Aug. 16, I think SHLD offers a great short trade.
Traders have moved the price of SHLD up and down this year. A 170% gain in the first quarter was followed quickly by a 40% decline.
On Monday, the stock enjoyed a big one-day move, gaining 5%. SHLD confirmed that it would be completing a previously announced spinoff of some retail outlet and hardware stores in a rights offering. This story feels like it is meant to distract traders ahead of announcing its quarterly earnings later this week. The company is expected to report a loss on Thursday.
I think SHLD should drop to about $47 on the report, a level where both the weekly and daily Bollinger Bands will offer support. That would be a decline of about 13.5% from Monday’s close.
One of the factors supporting SHLD’s stock price over the past few years has been its book value. Most investors think of the company as a real estate play rather than a retailer. A recent article in Barron’s pointed out that Lampert is restructuring the company to allow its real estate value to be realized. They said the company could be worth up to $100 a share after the restructuring. However, I was able to find a similar story in Barron’s from 2008. The stock has not done well since then, despite the value of the real estate and Lampert's efforts.
SHLD is about 75% below its 2007 highs. The idea that the company holds valuable real estate has been widely known for years. Yet the stock has been unable to reach its old highs.
One reason for this could be that the company's tangible assets have been declining. Tangible book value, which includes real things like real estate and store inventory, has fallen 77% in the past four quarters. Now, 82% of the company’s $42.58 book value consists of intangible assets. Competing retailer J.C. Penney (NYSE: JCP) has no intangible assets as part of its book value. JCP trades at about 1.4 times its tangible book value. SHLD seems very overvalued trading at about 7.1 times its tangible book value.
This quarterly earnings report should be an opportunity for investors to notice the trend in book value and dump the stock. So I recommend buying SHLD August puts that will expire on Friday. The short time until expiration of the options maximizes the bang for the buck. One way or another, the market will react to the earnings on Friday, so the trade should be closed shortly after the open on Friday.
At the time of this writing, the SHLD Aug 57.50 Puts were trading at about $4.75. They will be profitable if SHLD drops below $52.75, about 3% below Monday’s closing price. They would be worth about $10 if SHLD falls to $47 a share. The strike price of the option is about 5.8% above Monday’s close, so the put contract will have some value unless SHLD adds another 6% to its price.
Recommended Trade Setup:
-- Buy SHLD Aug 57.50 Puts at $5 or less-- There is no stop-loss because the trade will be closed on Friday, after the open, at market price-- Set the initial target at $10
While the sector is hanging on by a thread, shares of this company have already started breaking down.
A number of technical failures point to a great opportunity for short sellers to profit.
Goldman's bearish outlook tells me that value is going to be an important quality when assessing stocks for the next few years.