This morning, the stock market had a small tizzy, and while we’re so close to an all-time high! That’s okay — small hiccups are part of the normal price action of any good breakout. The catalyst for this morning’s hiccup: Macy’s reported earnings. Perhaps the real problem is that Wall Street is more worried in general, not disdainful of Macy’s results.
Macy’s beat across the board on P&L performance metrics. It even delivered better comparable sales that forecast. Management also raised their full-year guidance. This was also the third quarter of positive comparable sales, albeit a small one.
So on the surface of it, this is a strong report card for the team in charge. Yet the knee-jerk reaction is for traders to sell the stock down 9%. Coming into the earnings report, Macy’s stock was already up 60% year-to-date. This equals Amazon’s (NASDAQ:AMZN) rise, and is three times better than, say, Walmart (NYSE:WMT), Target (NYSE:TGT) and the SPDR S&P Retail ETF (NYSEARCA:XRT)
Macy’s CEO note the strong economy so the 2018 environment is still conducive to better days ahead. But I am a fundamental trader and I don’t like to chase upside “hopium,” even though there is technical upside potential on the weekly chart.
So instead of buying M stock and risking $40 to buy the shares with no room for error, I use options where I can build a buffer between current price and my level of risk.
In spite of the earnings dip, management is executing well on plans and without giving the house away. In addition, Macy’s stock is cheap. It sells at a 12 price-to-earnings ratio so there is value even before this dip.
Owning the shares at a discount from here is not going to be a mistake in the long term. I am confident that in the long term, I can profit from owning them should price fall through my levels and I get put the stock.
Technically, Macy’s stock had run so far coming into this earnings report so it is natural that investors are booking some profits even on good news. The short-term reaction to earnings has little to do with the quality of the report.
I consider this trade a bet on value in M stock … but at a lower price. I am not a fan of the retail sector. Wall Street experts have been on hold for the stock so maybe a dip would spur a few upgrade headlines. But it may take a few red days first since it is still trading above their average price ranges.
The Trade: Sell the M stock Jan 2019 $30 naked put. This is a bullish trade where I collect $1.40 to open. Here I have an 85% theoretical chance of success. But if Macy’s stock price falls below my strike, I accrue losses below $28.60.
Selling naked puts is daunting. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell the M stock Jan 2019 $30/$28 bull put spread, where I have the same odds of winning. This spread would yield 15% on risk.
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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.