Dollar Tree, Inc. (NASDAQ:DLTR) reported earnings and Wall Street hated it. The stock is down as much as 14% on the headline. Management missed on several accounts, so the punishment is appropriate in nature, but perhaps over done in size. And therein lies my opportunity with DLTR stock.
Today, I want to initiate a bullish trade on DLTR to take advantage of the elevated premiums caused by the stock-specific dip combined with the elevated levels of the high CBOE Volatility Index (INDEXCBOE:VIX) situation.
Dollar Tree missed on comp sales more so on the acquisition of Family Dollar side than its core stores. Nevertheless, traders are punishing the whole unit. While markets are this nervous, companies cannot miss on earnings or sales expectations and not expect consequences. So I don’t blame the sellers, but I will take advantage of it with caution. Furthermore, forward guidance was less than expected.
I could buy the shares outright and risk $94 with no room for error, and then hope for a long-term rally so I can profit. But I am not that brave.
Instead I will use the options markets where I can place my risk below proven support. This way, I build myself plenty of room for error just in case the selling persists and just in case the equity markets continue to drift lower for the next few weeks.
Fundamentally, Dollar Tree stock is not cheap. In fact, from a price-to-earnings ratio perspective it’s just as expensive as Walmart Inc (NYSE:WMT), and 30% more expensive than Target Corporation (NYSE:TGT). Clearly it’s not a screaming buy. Wall Street experts are in limbo on the stock.
Most analysts are split between buy and hold status, so no help from them. After this dip, DLTR is trading 20% below their average price target, so clearly they have been wrong and some could adjust their numbers lower. If so, then more selling would follow on those headlines.
Technically, the stock needed to hold $100-per-share for its neckline for an inverse cup & handle bearish pattern. This dip somewhat satisfies the measured move of said pattern with some room below.
The Bet: Sell the DLTR AUG $65 put and collect $1 per contract to open. Here, I have a 85% theoretical chances that price will stay above my level. Else, I will accrue losses below $64.
Selling naked puts is daunting, especially near all time high stock markets and a high VIX. Those who want to mitigate that risk can sell spreads instead.
The Alternate Bet: Sell the DLTR AUG $70/$65 credit put spread, which would deliver over 15% in yield, but with a much smaller risk. Both set ups have about the same odds of success and neither require a rally to win.
Ultimately, 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.