Last week I mentioned selling Sears Holdings Corporation (NASDAQ:SHLD) January $37.50 puts for $4.50. They last traded at $8.22. At one point on Thursday they traded above $9. That’s a loss of 90-100%. Fortunately I limited my notional exposure to under 5%. So the loss is less than half a percent of the portfolio. I’m not happy about that, but stuff happens. In this business you have to get out of bad deals and stay in the winning deals (how about that MGIC Investment (NYSE:MTG)?). That is the Holy Grail.
Sears has a credit problem and a vendor financing problem. The 6.625% Notes due 2018 traded at 76 today–they’re yielding almost 12%. Hmmm. Isn’t that interesting? Some of the sellers are forced sellers. They are selling because the credit rating agencies are downgrading the debt. I bet some hedge funds shorted the debt to front run the rating agencies. I’m not that clever. I didn’t foresee that the unthinkable (a Sears bankruptcy) would become thinkable.
Now, taking a step back, does it make sense for the market to be pricing in default risk at Sears Holdings? Is Eddie Lampert really going to let this child of his die? His blood, sweat, tears, and reputation are all on the line. Wouldn’t it just make more sense to reduce the probability of default to zero? Retrench. Close stores. Lower lease expenses. Don’t be stubborn and open more stores.
I think Eddie Lampert realizes how serious the situation is. He knows he runs a retailer that is not systemically important to this country. Unlike some Wall Street executives whose entities failed in the crisis, he has a 0% probability of getting bailed out. So he has to liquidate. He has to sell the real estate that competitors are interested in.
I like Sears Holding bonds. Where else can you earn 12% with this kind of risk/reward?