by Tyler Craig | March 26, 2013 8:41 am
Despite last week’s strong quarterly earnings report, shares of Tiffany & Co. (NYSE:TIF) look fatigued in the short-run.
News of the jewelry retailer’s fourth-quarter EPS of $1.40 was initially cheered by Wall Street causing the stock to gap higher by 3.3% on Friday. However, the euphoria quickly soured, and with TIF now down 2.7% since Friday’s open, the gains from the earnings gap have all but disappeared.
The stock has rallied 37% off its June 2012 lows and 19% year-to-date, and some analysts contend the stock appears overvalued at current levels. Followers of fundamental analysis might cite the rich valuation as a reason for TIF to consolidate or perhaps retreat in the coming weeks.
Click to Enlarge Technical analysis offers up a few additional reasons to be cautious. Take the post-earnings reaction, for instance. Friday’s failed rally attempt resulted in the formation of an equal pivot high at the $71 zone. While the development of a double top might not portend an imminent correction, it could at least indicate TIF is transitioning into more of a neutral trend.
TIF also is testing a short-term support level at $68. If the stock breaches this area, more downside is likely to come.
The options market offers a unique strategy to exploit the transition of TIF into a more neutral to mildly bearish trend. Rather than shorting the stock outright — which would be an aggressive bearish bet ill-suited to generate profits if the stock merely meanders sideways — we can sell an out-of-the-money vertical call spread. The short call spread (AKA the bear call spread) allows traders to bet that a stock will fail to rise above a certain level.
In the case of TIF, you could sell the May 72.50-75 call spread for 45 cents. Provided the stock remains below $72.50, the call spread will expire worthless, allowing you to pocket the initial credit received. The risk is limited to the distance between strikes minus the net credit, or $2.05. The potential return on investment for the suggested spread is 45 cents divided by $2.05, or 22%.
The beauty of the trade is that TIF doesn’t have to undergo any type of major correction. Simply consolidating for the next month will be adequate to turn a profit.
To manage the risk, you could either exit if the stock breaks above the double top at $71, or when it reaches the short call strike at $72.50.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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