Nike Set to Tee Off: Bearish Put Ratio in Play
Nike Inc. (NYSE: NKE) is due to report earnings for its third quarter, which began Dec. 1, after the market close today. Consensus estimates are for 88 cents per share on revenue of $4.65 billion, which is seen to be a 4% to 5% jump over a year ago.
We saw a big bearish put strategy this morning that one investor is using to play the event. Before I describe that put ratio play, letís go over some of the fundamental issues for NKE. Sporting a 18.5 trailing P/E multiple, NKE is a global retailer with a powerful international brand. As it recovers from the recession with solid execution of its growth strategy, most of the news has unfortunately been focused on its commercial relationship with Tiger Woods.
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But that hasnít seemed to upset investors who stay focused on the fundamentals, and the stock price has barely noticed either, hitting a new 52-week high this month. Some are probably saying this week that the new highs were the product of Woods returning to golf. In any case, it seems that investors are very comfortable paying a high teens multiple for the brand and the growth, with or without the star player.
According to OptionsHouse Research, with 20 analysts covering NKE, the high and low estimates for todayís EPS data are 95 cents a share and 80 cents a share, respectively. Of those analysts, seven have ìStrong Buyî ratings on the shares, while two are considered ìModerate Buyî and 12 say they are a Hold. None have ìSellî ratings on NKE.
Clearly this stock will be watched closely to see how the company has recovered from both the recession and the Tiger Woods scandal. NKE leadership was optimistic in their last report that sales and consumer sentiment were improving, and weíve had lots of surprising detail lately from retailers that the death of the American consumer has been greatly overexaggerated.
And since NKE is truly a global brand for athletic foot wear and apparel, they may be one of the brighter spots on the consumer front, benefiting from the recent Winter Olympics and the upcoming World Cup. Before we look at the stockís strength of late and its past reactions to earnings events, letís see what one investor did this morning to prepare for a possible disappointment.
The graph above shows the risk/reward dynamics of this moderately bearish play as of today, with three days to March options expiration. This investor is willing to risk about 18 cents per share on a bet that NKE could fall back below $70 in the next two days after tonightís report. The position cost a total debit of $45,000 (2,500 x $0.18 x 100 shares per contract)
This ì1 by 2″ ratio spread will realize proftis all the way down to $65, with a maximum potential gain of $4.82 ($5 spread width minus initial debit paid) to March expiration. But below $65, it has all the risk of a naked short put position since the investor sold twice as many of the lower strike April puts. And that naked short position essentially doubles after the March options expire because 5,000 of the April puts were sold. Thatís why the profit begins to erode below $65, leaving the position with potentially unlimited losses, or at least to zero.
The great thing about this strategy is that it could be either a hedge for an investor who is already long NKE shares, or it could be a speculative trade betting on bearish reaction to tonightís report. Either way, the investor-trader is playing the event for a relatively affordable all-in cost of just 18 cents per share on 2,500. And the position is built on the idea that while NKE could drop a few dollars this week, the stock is a good investment at that point and can be bought outright or through assignment of the April puts.
The investment is small, but the potential reward is big. And it looks like a smart play to me because while I donít know exactly what the market will do with NKE in the after-hours session and over the next two days, I think the stock will stay above $65.
Why is $65 so key?
If you look at the chart of the past year, NKE has been performing like a technical traderís dream. The stock bumped up against resistance at $60 in the middle of 2009, and then used that level as support for the past six months. Also note how the $65 area was resistance for last quarter of 09, and then it finally broke through in the past few weeks. Most investors and traders will be looking to buy NKE at $65 if they get the chance, and should some truly shocking news take the shares below that, weíll see plenty of buyers before it gets to $60.
From a report published on the OptionHouse Research tab this morning, you can get a rough idea of what to expect from NKE stock reaction to todayís earnings. The MidnightTraderís Earnings Notebook for NKE had some of these highlights for the past year:
Within the data pool weíve accumulated on the stock, NKE is mostly a narrower mover between the sessions following extended-hours earnings reports. It posted flat next-day performance in one event, and cut or reversed its after-hours performance in next-day trade in 13 of 21 quarters. In the near-term, the stock favors reversing direction between the sessions, doing so in three of the last four quarters. On Dec. 17, 2009, NKE advanced 2.4% in evening trade after meeting revenue expectations and beating on earnings. The stock saw its upside cut back the next day, closing the Dec. 18 regular session with a 1.8% rise. On Sept. 29, 2009, NKE firmed 4.1% in after-hours trade after beating earnings expectations. The stock soared higher the following day, ending the Sept. 30 regular session up 7.6%. On June 24, 2009, NKE declined 4.7% in evening trade after meeting revenue expectations and beating earnings estimates. The stock narrowed its downside the following day, ending the June 25 regular session down 3.2%. On March 18, 2009, NKE declined 4.1% in after-hours trade after meeting revenue expectations and beating on earnings. The stock reversed direction the following day, closing the March 19 regular session up 1.2%.The complete MidnightTraderís Earnings Notebook for NKE goes all the way back to 2004. Even though the post-earnings reactions are mixed, what stands out is that the stock moves tend to average under 5%. Bears may have a chance to play the short side with the put ratio we saw today, but bulls will definitely be licking their chops to buy when given the opportunity.
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