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Background

Michael Kors Holdings Ltd. (NYSE:KORS) will be announcing their quarterly earnings tomorrow morning (Tuesday 11/13), before the market opens along with other retailers including Target (NYSE:TGT) and TJX Companies (NYSE:TJX). Since KORS' IPO almost a year ago, the clothing designer and retailer has successfully beat analyst earnings estimates in 3 consecutive quarters. Analysts have been raising estimates in each of the past quarters, including estimates for this reporting quarter, KORS' 2nd quarter of their fiscal 2013 year.

Up approximately 100% since their IPO, KORS has been a shining light in the IPO market surrounded by the darkness of the social media stocks, which came public in the same time frame. KORS, has been on a short-term 10% decline over the past 2 weeks, but has support above $50 which is being tested today. With earnings reporting tomorrow, we will see if KORS will be reversing its short term down trend, or continue its fall if it breaks its support.

Way To Trade

We cannot guarantee which way the stock will trade after earnings, but we can look to the option market to measure the expected move. We know, no matter which way the stock trades, KORS option premium will take an enormous hit. As of pre-market 11/12, November options expiring this Friday have an Implied Volatility (IV), of 139%, while December options have an IV of 70%, and February options just 59%. With an IV of 139%, the option market is pricing in an expected move of $6.60 in either direction by Friday expiration. The following strategy will allow traders to use a neutral position to capitalize on the volatility contraction after the earnings announcement.

Neutral: Iron Condor

With an expected move of $6.60, we would use an Iron Condor with a range outside the expected move. Trading currently around $50, we expect KORS to trade around either $57 or $43 by Friday expiration. An Iron Condor Strategy is successful if KORS trades within the short strike range at expiration. Below are the stats for the trade.

  • Strategy: Buy 35 Strike Put, Sell 39 Strike Put, Sell 60 Call, and Buy 65 Call
  • Probability of Maximum Profit: 80%
  • Maximum Profit: $55/ strike
  • Maximum Loss: $450/Strike
  • Probability of Maximum Loss: 7%
  • Return on Capital: 12% over the next 5 days! If maximum profit is earned.

For a higher probability of Maximum Profit, a trader can extend strikes further out of the money, which will limit the potential maximum profit, while increasing the probability of success. As KORS trades throughout the day, strikes should be adjusted as probabilities and volatilities change. This example is a good foundation for an Iron Condor the morning of the day before an earnings announcement.

Source: Michael Kors Earnings Trade: 12% Return Possible Over 5 Days