Even though the retail sector as a whole has done little to inspire confidence, trendy teen retailer Abercrombie & Fitch (ANF) is a favorite on Wall Street. The firm’s turnaround efforts have sparked a round of bullish sentiment from the brokerage community, helping to push the shares more than 30% higher so far this year.
If you ask the analyst community, the answer would be a resounding “yes!” Data from Thompson/First Call reveals a hefty 16 “buy” ratings, compared to 18 “holds” and one “sell.” Furthermore, analysts at JPMorgan and Jefferies have recently recommended buying ANF stock ahead of the company’s second-quarter earnings report on Thursday morning.
Taking a closer look at earnings expectations, Abercrombie earnings are expected to come in at 11 cents per share, down from 14 cents per share in the same quarter last year. Revenue also is seen declining year-over-year, dipping to $908 million from $946 million a year ago.
Despite the poor year-over-year comparisons, analysts remain optimistic. For instance, EarningsWhisper.com reports that the whisper number for Abercrombie’s Q2 earnings report arrives 5 cents higher at 16 cents per share, which would mark a year-over-year gain for the company. This fundamental optimism is not without merit, either — according to data from Zacks, Abercrombie has only missed Wall Street’s earnings expectations twice during the past two years.
On the other side of the sentiment coin, short sellers are swarming all over ANF. In fact, roughly 16.5 million shares — or a whopping 23% of the stock’s total float — are currently sold short. At ANF’s current average daily trading volume, it would take nearly 10 days for this short position to be repurchased. In other words, there is potential for a sizable short-covering rally if Abercrombie’s quarterly report can force these shorts into hiding.
That said, it appears the shorts might be taking some precautions.
Turning to the options pits, the weekly Aug $30 put/call open interest ratio has plunged to a reading of 0.64 during the past week. By comparison, the front month September put/call open interest ratio arrives at a more bearish reading of 1.53.
So, with this conflicting data, how does one trade ANF heading into earnings?
Married Put on ANF Stock
Assuming you are looking to follow JPMorgan’s and Jefferies’ suggestions and buy ANF stock, there are ways to protect your investment so you aren’t burned by a bad earnings reaction. In fact, by using ANF options — specifically, a married put trade — you can protect your investment entirely or simply limit losses.
By using this strategy, you would purchase one front-month at-the-money or out-of-the-money ANF put for every 100 Abercrombie shares purchased. The strike of the purchased put should reflect your risk tolerance — i.e., an at-the-money Sep $43.50 put offers full protection, with losses limited to the cost of the put and brokerage fees, while an out-of-the-money Sep $42 put would allow for some slippage in ANF stock to see the trade play out.
For example, let’s say that you want to buy 100 shares of ANF (currently trading for roughly $43.50 per share). You could protect those shares by purchasing one Sep $43.50 put, which was recently selling for $2.24, or $224 per contract. In the end, the total cost for your option position would be $224, while the stock position would total $4,350 (excluding brokerage fees).
In this trade, the put option acts as short-term insurance for the long stock position. If ANF closes below $43.50 per share when September options expire, you would be able to exit the position while only suffering the loss of the cost to purchase the Sep $43.50 put. If ANF holds above $43.50 through September expiration, you can roll the Sep $43.50 put forward into October if you feel you still need the protection.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.