The past three earnings cycles have delivered some tremendous post-earnings successes in stocks like Amazon.com (AMZN), Priceline.com (PCLN), Best Buy (BBY), and Apple (AAPL). J.C. Penney (JCP) broke my streak in dramatic fashion. In an earnings shocker, JCP disappointed just about everyone and received a one-day discount of 20% in return. This was JCP's worst one-day performance ever. The chart below includes some important technical milestones for the stock.
J.C. Penney gets sharply marked down in response to disappointing earnings
Source: FreeStockCharts.com
While I did not officially present JCP as an earnings play, I did hold onto speculative call options into the earnings announcement. I interpreted a sharp drop in the put/call ratio as a bullish sign. Over the past week, the put/call ratio dropped close to 52-week lows which were set just ahead of JCP's January 27th 19% one-day gain. Moreover, the put/call ratio soared in March ahead of a big drop in JCP. So, it seemed that options traders have had a good pulse on the stock, at least in recent months. However, at the same time, shorts were increasing. As of April 30, shorts were 24% of JCP's float. Shares short increased 18% over two months. In other words, shorts were likely hedging by buying calls and/or locking in existing profits.
My bullish positioning was a 180 degree turn in strategy from my observations and conclusion in late March:
With the excitement wearing out on JCP - about half the heady gains from January 26 are now gone - I am guessing shorts will descend again upon JCP. Indeed, put buying soared on Friday across March, April, AND May expirations…The open interest in May is already heavily weighted in favor of puts. Friday's 16-to-1 put/call volume adds to an open interest favoring puts 2-to-1. These options expire AFTER JCP's next earnings announcement on May 14. Clearly, a large group of traders and investors believe JCP's new pricing initiative will suffer a poor start.
I completely overwrote this analysis by selectively over-emphasizing the decline in the put/call ratio. I have recorded several lessons from this episode of allowing the put/call ratio to fool me:
- Heavily discount any lessons from the put/call ratio when trends run counter to trends in short interest. Hedging activity clouds the trading signal from the put/call ratio.
- Do not play earnings without doing a thorough analysis. In the case of JCP, I became over-enamored by ONE angle, one scenario.
- Almost always use options for earnings plays. They provide a solid cap on potential losses.
Be careful out there!
Disclosure: I am long JCP.
Additional disclosure: I am long JCP through call options
