2 Retail Stocks That Generate Big Bucks for Options Buyers

Long straddle strategies on Dillard's and Macy's stocks have been lucrative in the past

Aug 7, 2017 at 1:14 PM
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Earnings season is still in full swing, and a handful of retailers will report this week. What's more, we've identified two retail stocks as potentially lucrative trades for options buyers, regardless of which way they swing after earnings: Dillard's, Inc. (NYSE:DDS) and Macy's Inc (NYSE:M). Below, we'll take a look at how DDS and M shares are performing on the charts, and why the department store stocks could be ripe for volatility traders using the long straddle strategy.

Dillard's Straddles Have the Highest Win Rate

Since touching a five-year low of $45.51 after earnings in May, the shares of Dillard's have rebounded roughly 63% in short order, touching an annual high of $83.44 on July 31. The stock is now trading around $74.11 -- which represents a 23.6% Fibonacci retracement of the aforementioned rally.

Dillard's is set to report earnings before the open on Wednesday, Aug. 9. Ahead of the event, analysts and short sellers are skeptical, to say the least. Short interest represents more than three-quarters of DDS stock's total available float, or about two weeks' worth of pent-up buying demand, at the security's average pace of trading. And not one of the four analysts following the small-cap stock considers it worthy of a "buy" or better rating, despite the equity's surge to annual highs of late. A solid earnings report could prompt a short squeeze or a flood of upgrades.

DDS stock doesn't have the best history of earnings reactions, though. The shares dropped 17.5% the day after their May earnings report, and fell 8.3% in the session subsequent to reporting in February. On average, DDS shares have moved 6.9% in the day after earnings, regardless of direction, looking back eight quarters. This time around, the options market is pricing in a much bigger one-day post-earnings swing of 12.4%, going by Dillard's stock's at-the-money implied volatility (ATM IV) data.

However, as alluded to earlier, DDS has been a great stock for volatility traders who purchase at-the-money straddles -- put and call options at the same strike -- 12 days before expiration. According to Schaeffer's Senior Quantitative Analyst Rocky White, long straddles on Dillard's shares have generated the best win rate -- 74% -- of S&P 500 Index (SPX) stocks within the past two years. The average return on a DDS straddle has come to 21.9%, assuming the buyers held the straddle through expiration and closed at intrinsic value.

Macy's Long Straddles Have Gained 32.2%, On Average

Unlike Dillard's, Macy's stock has struggled since a 17% bear gap after the retailer's May earnings report. The shares have backed down from resistance in the $24-$25 region on several occasions, and fell to a six-year low of $20.85 on July 11, amid a broad retail swoon and pressure from Amazon. At last check, M stock is up 1.4% at $23.62.

Macy's will report earnings before the open on Thursday, Aug. 10. As we just mentioned, the shares were slammed after the company's most recent turn in the earnings confessional, and the stock has dropped or stagnated the day after five of its last eight earnings reports. On average, M stock has moved 9.6% in either direction the day after its last eight earnings releases, though the options market is pricing in a healthier one-day swing of 12.5% this time around, per Macy's ATM IV data.

Ahead of earnings, options traders have been upping the bearish ante on M stock. On the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), the equity's 10-day put/call volume ratio sits at 2.30, indicating more than two Macy's puts have been bought to open for every call in the past two weeks. This ratio registers in the 99th percentile of its annual range, pointing to a much healthier-than-usual appetite for bearish bets over bullish.

Similar to DDS, M stock has been among the best for long straddle buyers in the past two years. Using the same criteria as before, Macy's straddle buyers have averaged a gain of 32.2%, according to White -- among the best of all SPX stocks. What's more, M options traders have seen their straddles double in value 26% of the time -- also among the best.

Word to the Wise for Straddle Buyers

In conclusion, options traders expecting a major post-earnings move for Dillard's and Macy's definitely have history on their side. However, while the stocks have proved lucrative for short-term traders able to time volatility, it should be noted that both stocks' August-dated options are relatively expensive at the moment -- not surprising, considering a potential volatility catalyst is just days away. As such, it'd be wise for wannabe straddle buyers to make sure to buy their options at the right strike and for the right price, as both of these factors will contribute to both the speculator's maximum risk and breakeven levels.

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