- JCP's price has stabilized after a major decline.
- Long-term options indicate the market has significantly negative outlook on JCP.
- There is a high skew in long-term option premiums. This makes it expensive to hedge against further declines.
It's been over a year since Mike Ullman was reappointed as J.C. Penney's (NYSE:JCP) CEO. The stock price has declined over 50% since July of last year; however, prices have stabilized in the last few months. Long-term options on JCP provide an interesting opportunity for investors with both positive and negative outlooks on JCP's future. I used the January 15, 2016 options for my analysis; all option data is from OIC.
It's clear from the 1-year chart that the worst part of JCP's decline seems to be over. The price has rebounded somewhat from its low in February and reached a plateau in May. The 30-day historical volatility is currently 31.16%, down from 65.63% one month ago. On the surface, it appears that the market believes the worst is over. The implied volatility index for JCP (from OIC) is currently 45.15%, far below the high of 135.71% in October. However, all we can learn from the implied volatility index (or 30-day historical volatility) is that the market sees less short-term risk; long-term is a different story.
To make the point, I used the longest maturity options for JCP, expiring January 15, 2016. That gives 553 days to maturity from the day I recorded the data (7/12/2014), or a little over 1.5 years to maturity. The price of JCP as of writing this is $8.75 per share. The first thing to look at is the volatility smile.
Source: data from OIC.
You can see the implied volatility curves for both calls and puts against the strike price in the chart above. The most notable feature is the significantly higher premiums for OTM puts. This is a rough measure of skew, or in other words, the expected tail risk. I've written about the CBOE's SKEW index in the past, this analysis is looking at the same thing as CBOE's index. This shouldn't be all too surprising, the price has already declined significantly and the future for JCP is anything but clear. Naturally, there is a large premium for deep OTM puts; however, if you are willing to take the risk, selling such puts could be profitable. Of course, the most important factor is what your outlook on JCP is. I also see this as indicating that hedging is likely unreasonably expensive in the long-term. Selling calls is unlikely to be a great move at this point; however, if you believe that JCP is likely to be much higher in a year's time than consider OTM calls.
Now, I want to make one further point about JCP's long-term options. The open interest is very revealing about the market outlook.
Source: data from OIC.
About 56.77% of the open interest for the January 15, 2016 maturity is split between the $4 put and $5 put. There are far fewer open call contracts and only a few strike prices have more calls than puts. Coupled with the significant skew in the implied volatility, this indicates the option market is pricing in further downside in JCP's future.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.