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Try This Tiffany Trade Before Earnings

Heavy bearish sentiment sets up a contrarian spread


Luxury jeweler Tiffany (NYSE:TIF) is slated to release its fiscal fourth-quarter earnings report ahead of the open tomorrow morning.  Currently, Wall Street is anticipating a 2.2% decline in quarterly profit to $1.36 per share, while revenue is seen rising 5.2% year-over-year to $1.25 billion.

Tiffany doesn’t have a great track record in the earnings limelight, missing Wall Street’s expectations in each of the prior four reporting periods. Analysts appear to be a bit concerned that the company is in for a repeat performance, as earnings-per-share estimates have fallen by 6 cents during the past few months.

Those same bottom-line concerns have bled over into the brokerage community’s outlook for Tiffany.  Specifically, Thomson/First Call data reveals that only 10 of the 21 analysts following the stock rate TIF a “buy” or better, compared to 10 “holds” and one “sell” rating.  Additionally, the consensus 12-month price target of $68 represents a discount to TIF’s close at $69.59 on Wednesday.

Short sellers are also quite bearish on TIF’s prospects. Since the beginning of the year, the number of TIF shares sold short has spiked 38% to 11.9 million. As a result, nearly 13% of the stock’s float is now sold short, and would take almost eight trading days to cover at TIF’s current average daily trading volume. In layman’s terms, this wealth of short interest leaves TIF vulnerable to a potential short-squeeze situation.

If short sellers are concerned about a potential post-earnings rally from TIF, they certainly don’t appear to be buying calls as a hedge.  Looking at March (weekly) and April options activity, we find call open interest totaling a mere 9,041 contracts, compared to put open interest of more than 23,000 contracts. The resulting March/April put/call open interest ratio arrives at a bearish 2.57, with puts more than doubling calls for this period.

Peak put open interest totals 5,512 contracts at the deep out-of-the-money weekly March 64.50 strike, with another 3,175 puts open at the out-of-the-money March 67.50 strike.  By comparison, peak call open interest of 2,521 contracts resides at the out-of-the-money April 70 strike.

Given TIF’s strong price action, this heavily negative sentiment backdrop looks very enticing for a potential contrarian options trade ahead of earnings.  However, there has been some turmoil for Tiffany’s competitors in the luxury jewelry market — think Coach (NYSE:COH) and Blue Nile (NASDAQ:NILE), which both were punished recently for poor quarterly reports.

Granted, Tiffany carries much more clout that either of its competitors, but a little caution never hurt anyone. With this in mind, more cautious TIF bulls might want to consider an April 62.50/65 bull put spread. This spread was bid at 48 cents, or $48 per pair of contracts, at the close of trading on Wednesday.

The maximum profit for this trade is the premium received (48 cents), which you will keep as long as TIF closes at or above $65 when April options expire, while a maximum loss of $2.02, or $202 per pair of contracts, is possible if TIF closes at or below $62.50 when April options expire.

For those willing to take on more risk, the April $67.50/$72.50 bull call spread offers more opportunity. This spread was offered at $2.42, or $242 per pair of contracts, at the close on Wednesday. Breakeven lies at $69.92, while a maximum profit of $2.58, or $258 per pair of contracts, is achievable if TIF closes at or above $72.50 when April options expire.

Finally, implieds on weekly March options are pricing in a potential post earnings move of roughly 6.4%, which is highly favorable for both potential trading strategies.

As of this writing, Joseph Hargett did not own a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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