Stock Options To The Rescue! Bed Bath & Beyond (BBBY)
Today we’re looking at an option trade on Bed Bath & Beyond to get back to breakeven after a big decline in the stock.
Here’s what happened…
Bed Bath & Beyond (BBBY) has dropped 10% from yesterday’s closing price of $68.79 to around $62 after reporting second quarter earnings.
Here’s the deal…
The home furnishings retailer fell short of revenue and earnings expectations last quarter.
Earnings per share rose to 98 cents from 93 cents a year earlier, but they came up short of the $1.02 analysts were expecting. And sales increased 12% to $2.59 billion.
Management said third-quarter profits should be between 99 cents and $1.04 per share.
Here’s the kicker…
Growth is slowing at BBBY. Same store sales growth slumped to 3.5% last quarter. This was a big shortfall compared to the 3.8% growth analysts were expecting.
Obviously, slowing growth is never good. But slowing sales are a death knell for growth stocks. If management can’t deliver growth, investors are going to take their money to another retailer that is growing. It’s that simple…
Right now, management is searching for ways to rejuvenate their slumping growth. And they have some things cooking that could light a fire under their sales.
For instance, they recently acquired Cost Plus. The purchase added 259 new stores and a new e-commerce website. Unfortunately, I don’t think the additions will be enough to revive their slumping same store sales growth.
At this point, it’s time for BBBY investors to face a cruel reality… BBBY’s in trouble.
The good news is many investors are holding out hope that the Cost Plus acquisition will revive the company. So, BBBY will likely get a bounce in the short term.
Here’s what to do now…
Let’s assume you paid $7,000 to buy 100 shares of BBBY at $70 per share. At a current price of $62 per share, you’re down about 11% or $800.
Obviously, this trade hasn’t gone the way you had planned. You could cut your losses now and take a $600 loss.
But don’t forget, BBBY isn’t a total lost cause. They do have a plan to revive their slumping sales. And some investors will likely hang around waiting to see how those plans work out.
However, it seems unlikely BBBY will rally 10% so you can get back to breakeven.
Let’s use this as an opportunity to use a call ratio spread to lower your breakeven price so you can get BBBY at breakeven at a lower price. A 2:1 call ratio spread is executed by holding onto the existing stock while buying a call at a lower strike and selling twice as many calls at a higher strike.
Buy 1 BBBY October 2012 $65 Call and Sell 2 October 2012 BBBY $67.50 Calls.
This option strategy will lower your breakeven price. But it also caps your upside if BBBY soars above $67.50.
Right now, you can buy the $65 call option for $0.70 and you can sell the $67.50 call option for $0.35. Because you’re buying one of the higher priced options and selling two of the lower priced options, the spread doesn’t cost you anything to put on.
If BBBY is trading below $65 when the options expire in October, all of the options will expire worthless. You’ll still own the stock and the loss on the stock will be the same whether you buy the options or not.
However, if BBBY is trading above $67.50, the maximum profit will be realized. To calculate the maximum profit, assume BBBY is trading for exactly $67.50 at the October options expiration.
The $65 long call will be worth $2.50 and the two $67.50 calls will expire worthless. So you’ll make a $250 profit on the options. But you can also sell your 100 shares of BBBY stock at $67.50 per share. So, you’ll get $6,750 on the sale of the stock and $250 from the options for a total of $7,000.
In essence, you’re lowering your breakeven point from $70 to $67.50. And the worst case scenario is you take a loss that’s equal to simply holding onto your long stock position.
In my opinion, using a call ratio spread to lower your breakeven price on BBBY is a good way to rescue this trade.
Good Investing,
Corey Williams
Category: Stock Options To The Rescue!
