Among the rubble of the traditional retail companies there are a few winners. Michael Kors Holdings Ltd (NYSE:KORS) is one of them, so I am willing to bet long KORS stock, but with caution.
Even though the traditional retail sector has been a disaster trade, Michael Kors has had a great year. KORS stock came into its earnings up 11% since January. Compare this with Macy’s Inc (NYSE:M), which is down 50% for the same period.
This morning’s positive reaction to earnings is testament to KORS’ success so far. Kudos to management who is evolving to fend off the e-tailing assault brought upon by the mighty Amazon.com, Inc. (NASDAQ:AMZN).
The Long-Term Case for KORS Stock
While the end game is not yet set, the direction in which KORS is heading seems to be the right one. That is evidence enough for me that eventually they will come out winners. So, today I want to place a bet that the stock will not collapse in the next few months. This is different than saying it will rally because my set up will profit even if Michael Kors stock falls further from here.
Today, Wall Street loves the earnings and KORS stock is spiking on the event. This is a reaction that the stock needed technically. It was teetering on a trend line that would have had negative consequences.
Fundamentally, KORS’ price-to-earnings ratio is under 15, which is cheap in absolute terms, but when you consider that Apple Inc. (NASDAQ:AAPL) — arguably the best company on the planet — is also under 20, that isn’t solace enough for value. So I have to lean my bet against the strength of the price action and not just value.
My concern is with expectations. KORS price is now trading closer to the high price target on Wall Street. So unless analysts change their hold rating to buy, we could see a few price revisions lower, even if it’s just for profit taking purposes.
That’s why I use options instead of buying the underlying. There I can leave plenty of room for error just in case the price moves against my thesis.
Bottom Line on KORS Stock
Technically, the daily chart suggests weakness around $47.5. The weekly chart shows that $52 has been a failure level for over a year.
Given that the price has been rising of late, this leaves KORS stock technically vulnerable into a rising wedge. There is also the matter of an open gape to $38-per-share left open on the last earnings report. Although this is not a crash forecast, I have to acknowledge its existence.
The Bet: Sell the KORS May 2018 $37.5 put for 50 cents. Here I have a 85% theoretical chance of success. Otherwise, and if the price falls below it, I would suffer losses below $37.
Selling naked puts is daunting and into the retail sector it’s outright spooky. This is especially true since markets are all-time high stock markets. Those who want to mitigate that risk can sell spreads instead.
The Alternate Bet: Sell the KORS May 2018 37.5/$35 credit put spread. The spread has the same odds, but it would deliver 13% yield on risk. Neither trade requires a rally to profit. In fact the stock can fall an additional 20% and I could still retain maximum gains.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.