Stock Options To The Rescue! Guess (GES)
Today we’re looking at an option trade on Guess Inc to get back to breakeven after a big decline in the stock.
Here’s what happened…
Guess (GES) reported quarterly earnings earlier this week. And it wasn’t pretty. The shares are down 20% to around $27.00 after earnings fell short of Wall Street estimates.
Here’s the deal…
Guess is a Los Angeles based apparel and accessory company. They’re best known for their pricey denim jeans. But their recent quarter has left investors guessing about the company’s future.
Last quarter profits plummeted 29% from the same quarter a year ago. They made 49 cents per share. But they came up well short of the 51 cents analysts were expecting. Quarterly revenue also took a 6% dive. However, it was better than analysts expected.
Nevertheless, the damage was done.
The company was forced to slash their full year revenue and earnings estimates. They now expect revenue to fall between $2.62 billion and $2.65 billion, down from $2.70 billion to $2.74 billion. And EPS estimates were slashed from $2.50 to $2.65 to a range of $2.15 to $2.30.
Here’s the kicker…
Guess is struggling to adapt to the ever changing demands of fashion conscious consumers. And they’re losing business to the competition.
And more importantly, they don’t have a plan to get those lost customers back.
You see, they’re trying to get away from running as many promotions and discounts to get customers in the door. But it’s not working.
They hoped they could take away the discounts and customers would continue to buy their products. Obviously, if they can sell the same amount of product at higher prices, it would boost margins and increase profitability.
Well, guess what? It didn’t work.
Customers simply chose to spend their money somewhere else. And despite this startling revelation, management has given no indication they’re going to do anything about it!
Here’s what to do now…
Let’s assume you bought 100 shares of GES at $32 per share before earnings. The 19% drop to $26 per share has plunged your $3,200 underwater by $600.
At this point, breaking even is about the best you can hope for. But if you simply hold onto the stock, you need a massive reversal in the stock just to get there.
A bull call spread can lower the breakeven price. It’s done by buying a call at a lower strike and selling twice as many calls at a higher strike.
Buy 1 GES December 2012 $26 Call and Sell 2 GES December 2012 $29 Calls.
Right now, you can buy the $26 call option for $2.45 and you can sell the $29 call option for $1.30. So it doesn’t cost you any additional money to buy one $26 call and sell two of the $29 calls. The credit and debit offset one another.
If GES is below $26 when the options expire in December, all of the call options will expire worthless. You’ll still own the stock and the loss on the stock is the same whether you buy the options or not.
However, if GES is trading above $29, the maximum profit will be realized. To calculate the maximum profit, assume GES is trading for exactly $29 at the December options expiration.
The $26 long call will be worth $3 and the two $29 calls will expire worthless. So you’ll make a $300 profit on the options. But you can also sell your 100 shares of GES stock at $29 per share. So, you’ll get $2,900 on the sale of the stock and $300 from the options for a total of $3,200.
In essence, you’re lowering your breakeven point from $32 to $29. And the worst case scenario is you take a loss that’s equal to simply holding onto your long stock position.
In my opinion, a bull call spread is a great rescue strategy to get you out of GES with a smaller upside move in the stock.
Good Investing,
Corey Williams
Category: Stock Options To The Rescue!
