Sometimes, companies just get lazy. They rest on their laurels, and before they know it, consumers have passed them by. Business then slows down to the point where the company may find itself in a cash or credit crunch.
In those circumstances, companies often end up taking on a lot of debt and dig a hole they can’t get out of. Next move: They call in a turnaround artist. And many times, turnarounds can result in multi-baggers for investors because a great turnaround artist is worth his weight in gold. Other times, the turnaround fails and the company files for bankruptcy.
So, it’s tough to decide what to do with turnarounds. If you’re a shareholder sitting on losses, do you bail now to preserve capital, or do you double down and hope for the best? If you’re outside the situation, do you risk capital to speculate on the turnaround? In either situation, using call options is worth considering.
Rather than buy the stock outright, which may cost a lot of money depending on the stock price, using deep in-the-money call options can save you some capital risk. However, the farther out you buy those options, the more premium you’ll pay. Let’s look at some turnaround plays and see what might work.
J.C. Penney (NYSE:JCP) is attempting a turnaround with CEO Ron Johnson, who was lured away from Apple (NASDAQ:AAPL). This could take a long time, and right now, the market doesn’t appear to like the strategy and results. This is a retail operation and a complete remaking of the Penney brand. I think it’ll take awhile.
If you’re a shareholder or you’re thinking of speculating on the outcome, what’s the play? Right now, the stock trades at $18. One strategy is to buy nearer-term call options, so you don’t pay that much in premium. That way, as expiration approaches, you can evaluate how the turnaround is going and choose to sell the option for whatever you can get for it, or roll it over for a few months.
The May 12 Calls are going for about $6.50, so you’re paying about 3% to avoid committing a full $1,800 of capital to the stock, instead committing only $650 for 100 shares. I prefer this option over the longer-term call options. The January 2014 $13 calls are going for about $7. So, you’re paying an 11% premium to look farther out and avoid committing the full $1,800. The idea here is that if Penney surprises with great sales results in the next year, you’ll enjoy a return on both the intrinsic price of the stock, plus a premium.
The risk and premium are even higher with the January 2015 $15 Calls at $7.40. In this case, you’re paying a 25% premium under the assumption that Penney will succeed. The earlier it succeeds, the more premium you’ll recover on the back end. Your breakeven is $22.40, and you have to figure that if Penney does succeed, the stock will rise well beyond that price.
Burger King Worldwide (NYSE:BKW) is another intriguing situation. It’s making slight inroads into McDonald’s (NYSE:MCD) market share. Burger King had flat earnings in 2011, but they’re expected to improve to 61 cents per share in 2012, and to 72 cents in 2013, a full 15% increase.
While some analysts have real concerns about Penney’s cash position, Burger King isn’t going anywhere. The stock is at $17.61 at Monday’s close, and the July 15 Calls are going for $3.35. Because Burger King is farther along in its turnaround, quarterly results will tell a much clearer tale than Penney’s will. Thus, paying 4% premium makes sense here.
Jamba (NASDAQ:JMBA), maker of those famous Jamba juices, is an interesting situation. The company claims its turnaround was over in 2011. I disagree, especially because it’s still rolling out store expansions and new designs. You don’t do that if you aren’t in turnaround. Jamba is also aggressively adding stores — 50 to 75 this year — and that isn’t characteristic of a turnaround, either. This year will be its first to record an actual profit as a public entity.
Can Jamba survive? In this case, the stock is at $2.42. You could just buy the underlying shares for $242 for a hundred. But if you believe in the company, the July $2.50 calls are going for about 35 cents. That’s only $35 for a hundred-share lot via options. The stock can easily trade up to $2.85 between now and July, or you could hold on and see very little loss if the options expire worthless.
As of this writing, Lawrence Meyers didn’t own any securities mentioned here.