Geopolitical tensions hit stocks early Tuesday, but veteran traders know that in turmoil lies opportunity, and one options trader used the volatility as an occasion to go shopping – in retail nonetheless.
Sure, the industry has gotten slammed by bankruptcies, store closings, and brutal online competition. But tectonic shift or no tectonic shift, investors have been singling out some names that may survive in the new landscape. Yesterday’s options trade targeted one of the new champions, a company that’s outrun all its peers in the S&P 500 index this year: apparel conglomerate PVH (NYSE: PVH).
A block of 3,000 October 125 calls was bought for $4.30 and 6,000 October 130 calls were sold for $2.15. It’s called a “ratio spread” because of the 1:2 proportion. Here’s a breakdown of how the strategy can potentially play out:
- Owning calls fix the price where a security can be purchased. Every contract controls a round 100-lot, so in this case they can buy 300,000 shares of PVH for $125 if it goes to at least that level.
- Selling calls creates an obligation to deliver stock if a certain point is reached. To be precise, they’ll owe 600,000 PVH shares if it goes to $130 or higher.
- So they’re buying 300,000 shares but are on the hook to fork over 600,000? Isn’t that a “naked short?” Sounds dangerous.
- Well, it’s very likely they came into the session already holding at least 300,000 shares, which would cover that upside risk. So what’s the point?
- The point is that they will collect an additional $1.5 million from a move to $130. (That’s 300,000 shares X $5 per share.)
Source: OptionsHouse by E*TRADE.
But wait, there’s more because the transaction cost them nothing except commissions. In other words, they can spiff up their profit from a small rally, but also don’t stand to lose their shirts if the shares head south.
The only drawback is that they surrender gains that would occur from a breakout through $130. But they may view that level as resistance because it’s held the stock in check for the last three years.
PVH rose 0.31 percent to at $126.62, but the ratio spread was detected about halfway through the morning when the stock was still chopping below $125. The trade also came after consumer confidence unexpectedly shot to its highest level since March.1
It was only last week that the parent of brands like Calvin Klein and Tommy Hilfiger leapt to new highs on the heels of a blowout quarter. Earnings beat, revenue beat, and guidance was raised. Analysts gushed about its market-share gains—especially overseas.2
Bottom line: PVH has emerged as a new retail champion, and one trader added to a position yesterday.
1. Bloomberg: U.S. Consumer Confidence at Second-Highest Level Since 2000. 8/29/17. CNBC: Consumer confidence strengthens in August, beating expectations for a drop. 8/29/17.
2. Marketwatch: Calvin Klein parent PVH Corp. shares rise on earnings beat, raised guidance. 8/23/17. Bank of America Merrill Lynch: Taking share amidst the retail chaos. 8/24/17. Credit Suisse: International Providing Compelling Offset To North America; Reiterate Outperform. 8/24/17.