Stock Options To The Rescue! The Men’s Wearhouse (MW)

Today we’re looking at an option trade on The Men’s Wearhouse to reduce your cost basis and get back to breakeven after the recent decline in the stock.

Here’s what happened…

The Men’s Wearhouse (MW) shares are down 18% from $35.50 to $29 after quarterly revenue, earnings, and outlook fell short of Wall Street expectations.

Here’s the deal…

The men’s apparel retailer reported quarterly profits slipped to $26.9 million from $27.4 million a year ago.  EPS held steady at 52 cents per share.  But they missed earnings estimates of 55 cents per share.

The earnings miss was driven by weaker than expected revenue growth.  Last quarter sales grew a modest 1.1% to $586 million.  It was well short of the $593.9 million analysts were expecting.

What’s more, management’s guidance for the current quarter fell short of expectations.  MW said 2^nd quarter earnings would likely be $1.12 or $1.13 per share.  But Wall Street was expecting earnings of $1.22.

Here’s the kicker…

MW is in the midst of stringing together two weaker than expected quarters.  They missed last quarter and they slashed their guidance for the current quarter.

But it’s not as bad as it sounds… The weaker than expected quarters are essentially an issue with timing.

In 2010, MW acquired two uniform makers in the UK.  Last year MW rolled out new products in these divisions during the first and second quarter.  But this year they’re rolling them out in the 3^rd and 4^th quarter.

This essentially pushes back the sales and earnings they made during the first half of 2011 to the second half of 2012.

The result is weaker than expected earnings in the first and second quarters.  And the stock has taken a big hit.  But don’t hit the sell button on MW just yet.

The company affirmed their full year guidance.  So it’s safe to say the second half of the year will be better than expected.  Instead of selling MW, rescue the trade with options.

Here’s what to do now…

Let’s assume you invested $3,550 to buy 100 shares of MW at $35.50 before earnings.  At a current price of $29 per share, you’re down $650.  But you don’t mind doubling your position size (increasing it to 200 shares) because there’s a good chance MW will bounce back in the second half.

Selling the MW November $29 straddle is a great way to rescue this trade.

This is a short straddle.  It’s established by selling a call and a put with the same strike price and expiration.

In this case, we’re using the November expiration because it falls after they report 2^nd quarter earnings and before they report 3^rd quarter earnings.  Remember, we should see the impact of the uniform sales being pushed back to the second half of the year in the third quarter.

Right now you can sell the November $29 calls for $3.30 and you can sell the $29 puts for $3.30.  The trade results in a $660 credit.  It also sets aside $2,900 in your trading account to cover the purchase of 100 shares if the put option is exercised.

There are two possible ways for this trade to get you back to breakeven or profit on this trade.

First, if MW is above the $29 strike on November 16th (options expiration day).

In this case, the owner of the call option will exercise their right to buy your shares of MW and the put option will expire worthless.

Your 100 shares of MW will be called away or sold at $29… a loss of $650 ($3,550 purchase price – $2,900 sales price) on the stock.  But don’t forget, you get to keep both option premiums of $660.

You’re out of the trade at breakeven.  Not too shabby after being down more than 18%.

The other scenario is MW is below the $29 strike on November options expiration day.

In this case, the owner of the put option will exercise their right to sell you 100 shares of MW at $29 and the call option expires worthless.

You’ll have 100 shares of MW ‘put’ to you.  In other words, you’ll be obligated to buy another 100 shares of MW for $29 apiece.  And you still keep the $660 in option premium.

The result is you’ll now own 200 shares of MW at an average cost of $27.95 per share (100 shares @ $33.50 + 100 shares at $29.00 – $660 in option premium).  And you’ll be in a great position to profit from a strong second half from a lower cost basis.

Good Investing,

Corey Williams

Tags: MW Straddle, Stock Options To The Rescue! The Men’s Wearhouse (MW), Straddle Trade on The Men’s Wearhouse, The Men’s Wearhouse option trade

Category: Stock Options To The Rescue!