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JCP: Options Flow Suggests More Downside Pressure

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Two very hot story stocks this month have been Blackberry (BBRY) and JC Penny (JCP). Both have news headlines every day as the companies struggle to find something transformational that can revive their earnings.

JCP shares slid into the low $12 range into the big liquidation by activist Ackman and then bounced as high as $14 as optimism grew that the new (old) CEO could turn things around. That buzz seemed to pass quickly and shares dipped below $10 this week while put volume and implied volatility have exploded. More than 28,000 January 5 strike puts have been opened this week, suggesting a very dire outlook for the retailer. One simple way to think of this type of option flow is Professor Peter Carr's "DOOM" (Deep-Out-Of-the-Money) put metric. I worked with Peter for years and while 90% of his quantitative modeling was over my head, this idea is very simple: take the price paid for a far downside put as a proxy for the probability of default by expiry. On a $10 stock this means a $5 put bought for $1 (that's what someone paid for the JCP January15 5 puts yesterday) implies a 25% chance of default- since the $1 would pay off with $4 in profits if JCP share price went to zero.
JCP Daily Contract Volume
Source: Trade Alert


Another way to see the dire concern is in a sharply increasing implied volatility and put/call skew- basically implying a fat-downside-tail to the probability distribution for the options- JCP skew in the October options is very steep- with puts about 16 IV points above calls.

This type of dire concern can create a death spiral as the company loses credibility with lenders and vendors, and business costs start to spiral upward. While it's still possible the some sort of white-knight comes along to take JCP private or otherwise revive the business, the options flow suggests more of a view to the downside- and with ATMIV near 91% we can expect plenty of 5% daily swings to keep traders on their toes.

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At the time of publication, Henry Schwartz held no positions in the stocks or issues mentioned.


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