Let me start by saying that I am not a fan of brick-and-mortar retail stocks. I don’t believe that they have solved the Amazon.com, Inc. (NASDAQ:AMZN) riddle yet. Yes, they’ve made strides towards stemming the bleeding, but the wounds are still open. So today’s trade is just that: A trade inside a conservative portfolio, not a long term investment.
Gap Inc (NYSE:GPS) reported earnings, and the markets hated what they saw. The stock is falling 10% on the headlines. Management missed on operating metrics but most importantly, investors were disappointed with the comparable store sales.
Coming into the earnings event, GPS stock was already lagging the like of Macy’s Inc (NYSE:M) and Target Corporation (NYSE:TGT), and this dip will cause it to fall further behind., but I believe that this selling will eventually abate and the stock will find footing.
Today’s trade is mostly based on technicals but is backed by value. GPS is not cheap compared to, say, Macy’s, but it sells at a 15 price-to-earnings ratio, so there is not a lot of fat to trim — maning that the bottom on this dip should be close from here.
Technically GAP stock has been trading in a wide 12-month range. The $3 zone below $30 per share has been pivotal for years, so now that it has fallen back there I expect it to provide some support. Zones of contention often offer support on the way down.
Last November, this served as the launch pad for the rally to $35. Since then, GPS stock has successfully retested the zone twice especially in late April. I expect that some bulls will step in to defend the stock sooner than later. And therein lies the opportunity today.
Click to Enlarge But this being the first red candle on the headline, and it being this big, there will likely be more selling before stabilization. So I use options where I can sell downside risk while the put premiums are elevated so I can generate income from what others fear. Under current macroeconomic conditions I bet that owning GPS shares at an even deeper discount from here is not likely a major risk. So picking proper risk levels is paramount for a successful trade.
Then at the first signs of stabilization I can add a debit call spread to capture the rebound effort if and when it comes.
GPS Stock Trade Ideas
The Bet: Sell the GPS Sep $23 put and collect 45 cents per contract to open. Here I have a 85% theoretical chances that price will stay above my level. Else, I will accrue losses below $22.55.
Selling naked puts carries big risk, especially for a stock as frothy as GPS. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the GPS Sep $24/$22 credit put spread. The spread has the same odds but would deliver 14% yield on risk. Neither trade requires a rally to profit. In fact the stock can fall an additional 23% and I could still retain maximum gains.
Click here for more my market thesis and get an ongoing free copy of my weekly newsletters.
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.
