Stock's Turnaround Could Score Traders 48% by Tuesday

While I generally suggest traders approach earnings reports with extreme caution, these catalytic events can be great profit generators. 

Over the years, I have found that stocks in the midst of a turnaround back to profitability from a period of losses can make for the best trades. Today's candidate, Burlington Stores (NYSE: BURL), is turning that profitable corner.

If timed properly, such turnaround stories can offer tremendous opportunity as confidence returns and analysts increase their earnings projections and price targets, sending investors pouring in.

When you are trading a turnaround stock, it's important to have top-down support for your thesis, not just cost-cutting for bottom-line improvements. 

Consumer cyclical and defensive stocks overall have been enjoying strength in 2014 as Americans open up their wallets for the best deals. Given the current trajectory of economic data, it seems that consumer health continues to improve, albeit slowly. 

Further, peers such as Ross Stores (NASDAQ: ROST) and TJX Companies (NYSE: TJX) both recently delivered strong earnings and sales and optimistic guidance, moving their shares higher. 

If you're not familiar with Burlington Stores, the company operates more than 500 stores under the Burlington Coat Factory, Cohoes Fashions, Super Baby Depot, MJM Designer Shoes and Burlington Shoes nameplates, all with a discounted name-brand theme. 

Friday's poor jobs number and subsequent pullback gives us an advantageous entry. Prior to that, BURL had been making new highs as the company approached its earnings release, scheduled for the morning of Tuesday, Sept. 9. The rally was fueled by analyst upgrades, with additional support coming from the strong results of its peers and upbeat consumer confidence.

BURL has been steadily increasing annual sales by roughly 6% over the past three years. This growth continued in the most recently reported quarter, as net sales rose 5.9% and comparable-store sales increased 2.7% year over year

Most important, though, is how Burlington is expanding margins (up 80 basis points in fiscal Q1), cutting costs and improving its bottom-line performance back to quarterly profitability. 

Analysts expect Burlington to lose $0.08 this quarter and then return to profitability next quarter with an $0.11 per-share profit. Based on my models, I don't think this quarter's results are going to blow away the Street, but I do believe guidance will be strong and come in at the upper end of previous estimates. That should be enough to send shares higher.

Being that no analysts have downgraded the stock or cautioned investors ahead of the report, I feel even more assured that Burlington will deliver strong results and shares will move to the $40 area, which is also a current target for several analysts. 

When trading around earnings, you have to be sure to select the proper option as premiums can quickly be sucked out once the earnings are reported. We will be selecting a call option with minimal time value, i.e., a longer expiration date, to counter this effect and help ensure profitability if the stock moves the way we want it to.

The one rub with BURL is that the stock is not heavily traded. That equates to wider bid-ask spreads in the options.  

Due to the lower volume, you should use limit orders to enter and exit the trade. It might also be a good idea to risk less on this trade than you would normally because of the wider spreads and the fact that we are trading through a volatile event.

BURL Call Option Trade

Today, I am interested in buying BURL Oct 35 Calls for a limit price of $3.05.

BURL Call Option
Risk graph courtesy of tradeMONSTER.

This call option has a delta of 65, which means it will move roughly $0.65 for every dollar that BURL moves, but it costs less than one-tenth of the price of the stock.

The trade breaks even on expiration at $38.05 ($35 strike price plus $3.05 options premium), which is 4% above current prices.

Our upside profit target will be $39.50 (just below that magic $40 mark), at which point our call option will be worth at least $4.50 (plus any time value). 

Once you enter the trade, place a good 'til canceled (GTC) order to sell the option at $4.50. I expect the target to be hit on Tuesday following the earnings report, but if it is not, I'm willing to hold for another two weeks.

Recommended Trade Setup:

-- Buy BURL Oct 35 Calls at $3.05 or less (use limit orders)
-- Set stop-loss at $1.20
-- Set price target at $4.50 for a potential 48% gain by Sept. 9 

If you have a question or comment about today's strategy, please send it to editors@profitabletrading.com.

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