By John Critchley & Christopher Yip
Staples (SPLS) missed first quarter earnings estimates last Thursday, coming in at 28 cents per share, short of the 32 cents per share expectations. To dampen last Thursday’s proceedings even further, management added a dismal 2011 outlook, lowering guidance for the rest of the year.
The stock gapped down in the premarket, plummeting from $19.65 to $16.70, a free fall of 15%. Shares of SPLS continued as low as $16.43 and even dragged OfficeMax (OMX) and Office Depot (ODP) lower, pulling them down 7%.
There is now a thesis gaining steam among some market watchers that the business model of these office retailers is no longer functional in the ‘internet age’. This is not a new thesis, others have voiced the opinion and analysis on the diminishing importance of brick-and-mortar businesses including those of Best Buy (BBY) and Barnes and Noble (BK).
As they face harsh online competition, traditional storefront retailers are having a hard time maintaining margins. This is especially true for retailers without a strong market niche. Retailers who are not providing any special or unique service serve as nothing more than oversized convenience stores for last minute items.
More and more consumers are looking to the internet for steep discounts and cheap merchandise. For products as standard as office supplies, it is not unusual to purchase pens, pencils, paper, and even ink and printers from websites such as Amazon.com and BuyOnlineNow.com. In order to stay afloat, SPLS along with OMX and ODP will have to drastically revise their business model to match the value of online retailers. Instead of opening up new stores, SPLS should seek to aggressively expand its internet sales.
There are two camps slowly emerging on the survivability of the traditional office supply retailer and we respectfully submit the jury is still out on this question. We present two option plays, one bullish and one bearish. Pick your poison. Wear the suit that fits you.
A Bearish Options Play
Are you in the ‘end is near’ bearish camp towards Staples? If yes, let’s look at a bearish options play: The 90-day implied volatility appears to be quite reasonable at the 27-30% level considering the dramatic selloff in the underlying. These options are trading significantly lower than 52 week 30 day IV highs of 45% reached May of last year.
To find any decent implied volatility option plays, one must go out at least to the September 2011 options, which present some compelling medium term option value.
Trade idea - The play: To take advantage of normal downside implied volatility skew and to benefit from any continuing downward pressure in staples over the next few months.
a) Buy September 17-15 put spread for $ .75. Receiving about 3.4% in Implied Volatility skew (buying 27.4 IV vs. selling 30.8 IV)
To finance this spread: Let’s sell the September 18 calls @ .50 This is approximately a 27.1% Implied Volatility.
Net debit: $.25
Risk: You will be Short the stock over $18, an 8.2 % upward move in Staples over the next couple of months.
A Bullish Options Play
Are you a ‘true believer’ in Staples? Believe that the selling was a complete overreaction and unwarranted capitulation. If yes, let’s look at a bullish options play:
The 30-day implied volatility appears to be quite attractive at the 30% level considering the dramatic selloff in the underlying. These options are trading at a substantial discount to the 52 week 30 day IV highs of 45% reached May of last year. The June ’11 options present the most compelling short-term value.
Trade idea - The play: To take advantage of normal upside implied volatility skew and to benefit from any short-term bounce in Staples.
Let’s do a June risk reversal for a small debit to take advantage of normal downside Implied Volatility skew.
a) Buy the June 17 calls for $ .40, paying about 27% Implied Volatility.
To finance this call purchase: Let’s sell the June 16 puts @ .30, this is approximately a 30.3% Implied Volatility.
Net debit: $.10
Risk: You will be Long the stock under $16. Only A 3.6 % downward move in Staples over the next 5 weeks.
Disclosure: The authors have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.