Macy's Earnings Rally Will Subside -- Here's How to Trade It

Macy's  (M)  stock rally in the wake of the company's earnings report probably won't last, and investors can use stock options to profit from the expected decline in the stock price.

Shares gained 1.3% Thursday to close at $38.38 and were recently trading at $40.35.

The rally appears to be because Macy's left its full-year earnings guidance unchanged and increased comparable-sales guidance. 

Still, the company's adjusted earnings per share missed Wall Street's expectations by a wide mark, and revenue was also below the analyst consensus. 

Fiscal third-quarter adjusted EPS was 17 cents vs. analysts' expectations of 41 cents. Revenue came in at $5.63 billion, which was less than the $5.64 billion analysts had predicted. 

On the technical side, the exaggerated price move on the chart forecasts a retracement lower.

The stock has been trending lower for the past two months. The chart shows the formation of a descending triangle, which is a bearish continuation pattern. On Thursday, the stock's price gapped above the upper Bollinger Band. That sets up a likely retracement back into range.

Expect to see the stock's price decline to $39 or less, with $38 a possible support level represented by the t-line. Momentum, as measured by the relative strength index, confirmed this. The RSI moved 5.5 points above the overbought level of $70.

Considering the weak fundamental and technical situation for Macy's, the odd upward surge may represent optimism about retailers and/or a postelection response. As a result, a couple of possible option trades appear attractive.

For those who own shares of Macy's, timing is excellent for a covered call. The Nov. 18 options contracts (expiring in exactly one week) will see a rapid decline in their premiums because of time decay, and opening a covered call now sets up three days of time decay by Monday. Historically, in the weekend before expiration, options lose more than 30% of their time value. The $40.50 call is very close to the money. The bid price of 0.79 on the $40.50 call option is almost all time value. Subtracting trading fees, you can sell this option for $70. (Obviously, a covered call strategy requires that you already own 100 shares of the underlying stock for each option you sell.)

For those who do not own shares, an equally attractive play is buying the Nov. 18 put option with a 40.50 strike price. Even though time decay will affect this contract as well, it will not take much to turn this contract profitable. The 40.50 put closed on Thursday at an ask price of $91. Including trading fees, the total cost is about $100. The break-even level is $39.50 per share. Referring back to the chart, the likely retracement of price will move below the upper Bollinger Band and might run into support at the t-line ($38.05). So this short put looks like a reasonable one-week swing trade with minimal risk of $100.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

Besides blogging at TheStreet.com, Michael Thomsett also blogs at Options Money Maker, the Top Advisor's Corner at Stockcharts.com, and Seeking Alpha. He has been trading options for 35 years and has published books with Palgrave Macmillan, Wiley, FT Press and Amacom, among other publishers. He is working on a new book on options math, to be published by Palgrave Macmillan in 2017.

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