Options Update: Sears Holdings Hit by Heavy Option Activity

• July 9, 2008
• Mark Fightmaster

Trying to SHLD Itself

Brokerage firm Morgan Stanley decided to take the whooping stick to the retail sector this morning, lowering its 2009 earnings per share estimates for companies by an average of 3% and lowering price targets by an average of 8%. Morgan Stanley noted that its lead indicator dropped 110 basis points last month and key drivers (i.e. home prices, food and fuel inflation, and employment) are “unlikely to improve in the near future.” The brokerage also feels that consensus expectations for 2009 are “unrealistic,” as analysts expect 14% growth in earnings. Continuing, Morgan Stanley named its “fading 5,” which includes today’s Options Update subject: Sears Holdings
. (More information on Morgan Stanley’s trip through retail can be gathered by reading Andrea Kramer’s blog coverage this morning.) Continuing the bad news for SHLD, Credit Suisse cut the firm’s price target to $65 from $70.

SHLD is weathering this news well, as it has lost less than 1% thus far. The stock’s drop has prompted heavy put and call activity today, which is what caught my eye.

According to today’s Intraday Volume Explosion List, SHLD has seen total put volume increase nearly 5 times the norm, with a majority of the activity focused on the July 80 contract (KTQ SP). This particular put has seen volume of 8,022 contracts on open interest of 18,157. Turning to the call side, SHLD has seen total activity increase nearly 6 times, with most of the action taking place at the July 80 call (KTQ GP). This call has seen volume of 8,117 on open interest of 19,200.

My initial suspicion was that we were seeing straddle positions at the 80 level, especially with the stock trading in the 75 region. When digging through the action, my suspicions were confirmed. All of the major transactions on the put (KTQ SP) had a corresponding transaction on the call side. Remember that the goal of a straddle is a sizeable move in either direction. In this case, the put would break even if the stock dropped to $74.60 (the strike price less the premium paid; 80 – $5.40) and the call would break even if it rose to $80.70 (the strike price plus the premium paid; 80 + $0.70).

Guarded Sentiment

According to Zacks, SHLD is tracked by only 3 brokerages. Two of these ratings houses deem SHLD worthy of a “strong sell” rating, while 1 maintains a “buy” rating. Upgrades or downgrades could move the stock in either direction; however, the biggest potential mover could be positive or negative initiations. Watch out for new coverage as the stock continues its performance (which we will deal with on the next page), as the fresh following could push the stock accordingly.

Options players are nowhere near as wishy-washy. In fact, the pessimism from this bunch is rather overwhelming. SHLD sports a Schaeffer’s put/call open interest ratio (SOIR) of 1.15, which indicates that puts outnumber calls in the front-3 month option series. Furthermore, this reading is higher than 93% of those taken during the past 52 weeks. In other words, the option pits have been more bearish just 7% of the time during the past year. Yes, this sentiment could unwind and push the stock higher, but is there reason to believe such a move will be made? Let’s see.

Fighting to Find Support

There is no way to put this delicately: SHLD is struggling. During the past 52 weeks, the stock has shed 50% of its worth. The slide has been exacerbated by the equity’s 10-month moving average, which it has not closed atop since May 2007. While this trendline pushes the stock lower, its 20-month counterpart lurks overhead just in case.

Also note that the round-number 80 level is now in a resistive position. This is troublesome for 2 reasons. The first is that this level acted as support in 2004 and may now enjoy its new role as resistance. The other troubling fact is that 80 is the site of heavy call open interest. As we wind our way to July expiration, we could see this level act as resistance. Of course, in our hypothetical straddle play, this resistance is troublesome only if the stock hasn’t dropped past $74.60.

Before issuing my verdict on SHLD, let’s briefly recap our overall view on the retail sector here at Schaeffer’s. As Todd Salamone pointed out in this week’s Monday Morning Outlook, we have an overall bullish outlook on the sector. As noted, the sector is performing well as a whole and faces pessimism. I’ll summarize by using a quote from Mr. Salamone: “This strong technical performance and positive economic data bodes well for the sector, and [it] could benefit from an unwinding of the heavy investor pessimism levied against the retail group.”

The Verdict? The technical issues facing SHLD may be too much for the stock to overcome. As with the entire retail sector, SHLD faces quite a bit of pessimism – but an investor looking for a bullish pick in the sector may be best served shopping elsewhere (Big Lots or Ross Stores perhaps).

If you have any questions or comments, make sure to email me. I will do my best to answer your question or address your concern.

Want more of my thoughts on the market? Don’t like my views and want to see those of my colleagues Andrea, Elizabeth, Jocelynn, Colleen, or Joe? Make sure to check out our Schaeffer’s Daily Market Blog section throughout the trading day.

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