Fade The Lowe’s Companies, Inc. Rally

LOW OptionsAfter a 10% Ackman-driven rally, Lowe’s Companies is due for a reversal

I believe it’s time to go short on Lowe’s Companies, Inc. (NYSE:LOW). This sentiment might surprise many readers. After all, LOW stock surged more than 10% following its first-quarter earnings report this week. But this rally won’t last.

The reason lies in this week’s news. First, Lowe’s missed first-quarter earnings and revenue expectations. Specifically, earnings came in at $1.19 per share, whiffing the Street’s forecast by 8 cents. And the damage should have been much worse.

Operating income was also lower, thanks to higher operating costs. However, Lowe’s managed to skew year-over-year comparisons through its share buyback plan. In other words, a lower share count helped push up earnings per share results.

Second, the “good news” that overshadowed this earnings miss doesn’t seem all that good. Lowe’s poached J C Penney Company Inc (NYSE:JCP) CEO Marvin Ellison. Many analysts believe this is an upgrade for Lowe’s, but I will say look at JCP’s stock price.

Ellison took over at JCP back in 2014. Before the Lowe’s announcement, JCP stock was down roughly 266% since Ellison took over. Granted, a lot of J.C. Penny’s problems stem from online competition and shifting consumer habits. However, he’s facing an equally daunting task at Lowe’s.

Specifically, the housing market itself is on the verge of a significant decline. Rising mortgage rates have sparked a short-term round of buying, but easy money for the sector is coming to an end. The outlook is not good, and that means considerable pressures for Lowe’s going forward — pressures that a shift in marketing strategy just won’t fix.

Third, the real reason LOW stock rallied following earnings had nothing to do with earnings or Ellison at all. It had to do with Bill Ackman’s $1 billion stake in the company.

Investors like to chase investments by people like Ackman and Warren Buffet. The problem is that these guys operate on a different scale than most of us. They can take advantage of leverage that most of us can only dream of having. Ackman has a plan, and it is likely a very profitable one for him, but that doesn’t mean you can buy LOW stock and chase his strategy.

So, LOW stock gets a sentiment boost following the news, but the underlying issues still remain. And that means a turn lower for LOW stock once this headline news blows over.

Technicals and Options for LOW Stock

Regardless of LOW stock’s longer-term outlook, the short term is signaling a decline. The shares have rallied into resistance at $95 and LOW’s 14-day relative strength index (RSI) is at overbought levels. LOW has also outstripped support at its 50-day moving average, leaving plenty of downside before prices stabilize. A fall to $90 is likely, while a drop to $88 or lower wouldn’t be out of the question.

On the options front, speculative investors are already bracing for the reversal. Lowe’s June put/call open interest ratio has ballooned to a reading of 1.22, with puts firmly in command. Peak put OI lies at the $80 strike, but most of those contracts were around before the Ackman surge. Traders have shifted their focus to the June $93.50 put strike, which now has more than 1,500 contracts in residence.

June implied volatility, meanwhile, is pricing in about a 4% move for LOW stock heading into expiration. This places the upper bound at about $98, while the lower bound rests near $90.

2 Trades for LOW Stock

Put Spread: Ackman and Ellison aren’t enough to get me excited about LOW stock. This is especially true given the problems facing the broader housing market right now. The smart move here seems to be to fade LOW stock’s post earnings rally and wait to see how the rest of the market reacts over the longer term.

Traders looking to fade LOW stock might want to consider a June $93.50/$92.50 bear put spread.

At last check, this spread was offered at 35 cents, or $35 per pair of contracts.  Breakeven lies at $93.15, while a maximum profit of 65 cents, or $65 per pair of contracts — a potential return of 85% — is possible if LOW stock closes at or below $92.50 when June options expire.

Call Sell: Those looking for a more neutral-to-bearish play might consider looking into a June $100 call sell position. At last check, this call was bid at 41 cents, or $41 per contract. A sold call allows you keep the premium as long as LOW stock closes below $100 at expiration.

On the downside, if LOW rallies above $100 prior to expiration, you could be forced to provide 100 shares at current market value for each call sold, which could be quite costly if you do not have enough stock on hand to cover the call.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

 

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Category: Options Trading Strategies

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