This Week We Had Our Best Trade In 2020

Summary

• Happy Labor Day.
• Don't forget to participate in our poll and cast your vote today!
• Our best trade in 2020 (thus far) took place this week, in a matter of <3-trading hours.
• What is more important - Luck or Brain?
• Luck is even more important than brain, but it seems like the former appears more often for those with the latter.

Hi Folks,

Hope all is well at your end.

First and foremost, we hope that you are coping well through this difficult times, and that you keep yourself safe, healthy, and happy.

Secondly, if you haven't done so, you can still cast your vote in the quick poll we run: https://twitter.com/TheFortuneTell5/status/1301437608602501121

We're here today to tell you two things:

1) To wish you a very Happy Labor Day. Enjoy the long weekend!

2) To tell you about the most profitable trade we had this year, which took place this week. When I say "this week" I actually exaggerate. This trade started on the last hour of trading on Wednesday and got closed on the second hour of trading on Thursday, so in reality, this trade was a live more only a couple of hours...

We bring you the relevant trading, just as they were originally posted.

First leg: Wednesday, September 2, 2020

SELL (to open) MIK 09/18/2020 10.00 CALL + BUY (to open) MIK 09/18/2020 7.50 PUT for a NET CREDIT of $2.00

Risk Rating: 3.5 >>> Maximum* Allocation: 4%

*Doesn't equate suggested!

A couple of weeks back, we mentioned our intention to re-establish a short position on Michaels Companies (MIK) when it gets to $10 or so. Since then, the stock has moved comfortably into double-digit range and today it even made a new 52-week high at $11.70!

It's important to start this trade with a warning: When it comes to technical analysis, we're playing with fire here!!!

MIK has broken both its long-term downtrend (red channel) as well as managed to take over the previous high of 2H/2019, so from a pure technical perspective - there should be a nice support in here.

This is, perhaps, the main reason why we don't short this stock straight rather playing around the Q2 earnings due on Thursday, September 3rd, before market open. It's now or never (at least for this quarter...)

Per SA:

• The consensus EPS Estimate is -$0.08 (a whopping -142.1% Y/Y) and the consensus Revenue Estimate is $1.01B (only -1.9% Y/Y).
• Over the last 2 years, MIK has beaten EPS estimates 63% of the time and has beaten revenue estimates 38% of the time.
• Over the last 3 months, EPS estimates have seen 4 upward revisions and 3 downward. Revenue estimates have seen 4 upward revisions and 3 downward. So quite a mixed feeling here by the market.

Analysts are also running price targets all over the place, ranging from $3 to $14 (average $7.78; median $6.63).

We believe that MIK is a business that simply can't perform well during such times.

We are talking about a company that owns and operates arts and crafts specialty retail stores for hobbyist and do-it-yourself home decorators in the United States and Canada. It operates Michaels stores that offer approximately 45,000 basic and seasonal stock-keeping units (SKUs) in arts, crafts, framing, floral, and home decor and seasonal merchandise.

We are talking about a company that last quarter (Q1/2020) recorded a Non-GAAP EPS of -$0.43 (misses by $0.57), GAAP EPS of -$0.43 (misses by $0.58), and revenue of $799.89M (-26.6% Y/Y; misses by $230.11M).Gross margin rate squeezed 1050 bps to 27.7%.

We are talking about a company that is carrying a debt-load of nearly $5B and alongside negative cash flow.

We are talking about a company that was sounding anything but upbeat on its operations only three months ago.

"Based on current trends, the Company believes it will use cash during its fiscal second quarter. Expected uses of cash during the second quarter include seasonal working capital and cash payments that were deferred from the first quarter. The Company expects to generate positive cash flow in the second half of fiscal 2020 and believes it has sufficient liquidity for the foreseeable future.

Given the continued uncertainty associated with the COVID-19 pandemic, the Company is not providing any additional financial outlook information at this time."

However, the Company also:

1) expects Positive cash flow in Q2.

2) has $300M under its revolving credit facility

3) sees its bonds trading with yields of only 6%-7%

4) expects to have sufficient liquidity to fund planned capital expenditures, working capital requirements, debt service requirements and anticipated growth for the foreseeable future.

Therefore, we are bearish but we rather make money out of the stock already pricing in the possible positive news/developments rather to expect a huge disappointment. Putting it differently, we find it easier to make money here assuming the stock won't move up (a lot) instead of expecting a 20% drop.

As such, our tactics here is simple.

We use the nearest-dated expiry (9/18/2020) as we only play the earnings (for now).

The way we structure this deal means that we would make money as long as MIK doesn't trade above $12 (7% above current market price) on 9/18.

Any lower price - and we end up making money. Nonetheless, there are small details to pay attention to. Here's a summary of the possible scenarios (per one stock; recall that each option/contract represents 100 stocks!)

Price 9/18	Short 10.00 CALL	Long 7.50 PUT	Premium	MIK position	Profit / Loss
>$12	MP-$10.00	Expire worthless	$2.00	Short the stock	Loss: MP-$12
>$10 & <=$12	MP-$10.00	Expire worthless	$2.00	Short the stock	Profit: $12-MP
>=$7.5 & <=$10	Expire worthless	Expire worthless	$2.00	-	Profit: $2
<$7.50	Expire worthless	$7.50-MP	$2.00	-	Profit: $9.5-MP

In case this isn't clear:

• If MIK closes > $10 on 9/18 - we become short sellers of the stock (regardless of the P&L)
• Only if MIK closes > $12 on 9/18 - we lose money (on a net basis)
• As long as MIK closes > $7.5 on 9/18 - our maximum gain is $2 per share.
• If MIK closes < $7.5 on 9/18 - we start making additional profit. The lower the stock - the higher the additional profit (on top of the $2)

And if $2 doesn't sound like a lot to you, let us say this:

1) Multiply the $2 by the number of contract you sell and then by 100. If you sell 20 contracts, that's 20X2X100 = $4000

2) If making 20% in 16 days isn't moving the needle for you - we're afraid we won't be of much help for your investment aspirations...

3) The annualized return on this trade (if successful of course = MIK closes below $10 on 9/18) is 3,267%...

Now, that's the fun-profitable part of this trade.

The less pleasant part is if MIK shoot up. In such case, we can lose a lot. As high as the stock goes (minus $12) - so will the loss.

Normally, we rate a naked call sale with a risk rating of 4.5 or even 5. In this case we use 3.5 because:

1) It's a very short-term trade.

2) MIK is up 1000% from its March lows.

3) Even the most bullish analyst doesn't see it worth more than $14.

So we certainly see a risk, but not as high as we normally do when it comes to a naked call sale.

If you wish to mitigate the risk (to the upside), you can buy another call, with a higher strike (12.50 or 15.00) that would put a cap on your maximum loss. Such a move would, obviously, decrease the potential gain you can make on this trade (if successful), but it would reduce the margin requirements substantially.

Full disclosure: We haven't bought such a protective call, and we have a pretty substantial position here, simply because we don't mind becoming short sellers of MIK at a net price of $12, post earnings (no matter how good they might be)

Second leg: Thursday, September 3, 2020

BUY (to close) MIK 09/18/2020 10.00 CALL + SELL (to close) MIK 09/18/2020 7.50 PUT for a NET DEBIT of $0.12

We opened this trade yesterday and there's no point in even analysing the ER of Michaels Companies (MIK). The only thing that matters is how the stock reacts. Badly. Very badly.

Data by YCharts

We could wait longer, and perhaps make more money... If so, that would come out of the $7.50 PUT (rising), less from the 10.00 CALL (falling).

Nonetheless, with 94% of the (combined) premium sitting in our pocket after only 1 day (actually less, as we executed the original trade at the last hour of trading yesterday...) - we really don't see a reason to mess around.

If we can talk our own book (sorry for being a bit too enthusiastic), we're extremely proud with this trade, since this is now (by far) our BEST TRADE OF THE YEAR (in real life) from a weighted total return.

We had (and actually still are, with few other options that we haven't suggested on the service) a pretty large allocation to this trade (and other trades) around MIK earnings, with the most reasonable outcome being us becoming short sellers of the name (again).

However, when a trade that you have a big allocation in, is making so much money, over such a short period of time - there's really no reason to mess around. You take the profit, say thank you, and move on.

Had we went short this name, the allocation would have been smaller, and the cost (MIK is a heavily shorted name) would be high. Using options has allowed us to leverage (the allocation), avoid paying high costs, and cash out with a total return that (on a weighted basis) is larger than a short position would be.

Such trades are obviously rare, but one you nail them - it's making a real difference in the portfolio.

What is more important - Luck or Brain?

Here's what we posted on the Wheel of Fortune (lively and lovely) chat room before we rap up this week:

Ok, it seems like we're good to end the week early, with the market searching for direction (i.e. -% or +2%?...)I'm still patting myself on the back for the MIK trade (stock is nearly 20% higher since we closed the trade yesterday; luck is as important as brain, if not more...)I had fun this week, as this was one of those weeks where it's tough to make money, yet we did/do! It's nice when the market goes up, but it's "easy money". For me, when it's becoming more complicated and when you feel that your skills are at good use - this is where I take more joy (and, admittedly, pride).Enjoy the long weekend. We'll probably post something before trading starts on Tuesday, but for you - it's a long, well-deserved, break

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