Does Abercrombie & Fitch (ANF) Have More Upside Potential?

Abercrombie and Fitch option strategies After months and months in the red ink, Abercrombie & Fitch ANF has shown a marked improvement in its recent sales numbers. Same-store sales grew by 22% (year over year) in December, easily topping estimates. Monthly sales numbers have been positive during the last six months after sinking dramatically each month between January 2009 and January 2010.

Investors have evidently noticed these improved numbers as the stock has shot up 60% in the past three months. Wall Street has noticed as well; earlier this week, Goldman Sachs GS added the apparel retailer to its “conviction buy” list.

The firm expects ANF to see additional upside amid “favorable fashion trends” and improving economic conditions. For one thing, the teen unemployment rate may be lessening, and more teens making money may mean more teens spending money. Goldman also set a price target of $70 and lifted its earnings estimates for 2010 (to $2.03 per share from $1.84) and 2011 (to $3.38 per share from $2.73).

Someone taking a contrarian stance might argue that ANF has rallied dramatically of late and is in need of a resting period. For both sides of the argument, we have outlined two option strategies below – one moderately bullish, one moderately bearish. All prices are as of Thursday midday, when ANF shares were trading at $55.50, down $0.15 for the day.

Moderately Bullish Option Strategy: Calendar Spread

Cautiously optimistic investors could consider a calendar spread using front-month and back-month options. By selling the front-month and buying the later month, a trader can play expectations for a slow and steady rise.

In ANF, a trader can sell the December 60 call and simultaneously buy the January 60 call, paying a net debit of $1.42. This is cheaper than buying the January-dated call outright, as the short front-month call helps offset the price of the later-dated option.

In a perfect world for this cautious bull, ANF shares would rise slowly (but not dramatically above the 60 strike) until December expiration and then continue to gain in value through the life of the January option. When the December option expires, gains are theoretically $60. The short call would expire worthless and the January call has advanced and has four more weeks of time value.

If the short call expires worthless, losses for the January long call option are limited to the overall premium paid if ANF is trading below 60 at expiration on January 21. Gains are theoretically unlimited at January expiration if the shares have rallied above the breakeven price. Breakeven is $61.42 at January expiration if the December call expires worthless and the investor holds the resulting long call until expiration.

If ANF is trading above $60 at December expiration, the short call will likely be assigned, creating a short stock position. This, together with the long call, is the synthetic equivalent of a long put and therefore has potential gains down to zero and losses capped at the premium paid. If the investor is still bullish on ANF, he would likely buy to close the short-stock side of the trade and leave the long call open.

Calendar spreads take patience and diligent management as expiration approaches in the short option. It's important that the trader maintain his desired market exposure, whether that is a naked long call, a synthetic long put, or no position at all. In most instances of a bullish calendar spread, however, the investor buy to close the shorter-term call or roll it forward (depending on the nature of the spread).

Moderately Bearish Option Strategy: Put Tree

Some investors may feel ANF has rallied too far, too fast, but don't think it will crater anytime soon (especially with the enthusiasm on the part of GS). This type of sentiment can be reflected by a put tree, which is appropriate for stocks expected to lose a little momentum but then stop falling.

The put tree is similar to a ratio put spread but the short puts are at different strikes. For example, an investor could open the January 60/55/50 put tree by buying the January 60 put, selling the January 55 put, and selling the January 50 put, paying a net debit of $1.55 per spread.

The maximum potential gain, occurring if ANF is trading between the short strikes (50 and 55) when the options expire, is $3.45, or the difference between the higher-strike short put and the long put, less the debit paid). Above the 60 strike, losses are capped at the $1.55 debit paid. (Breakeven on the upside is $58.45, or the long put strike less the debit paid).

Below the downside breakeven of $46.55 (the lowest-strike put minus the maximum gain), losses are similar to a long stock position, unlimited down to zero. In the unlikely event that ANF falls all the way to zero by January expiration, losses are capped at $46.55 because of the naked short 50-strike put.

Learn more about the intricacies of the put tree strategy at our free webinar next Tuesday (December 14) at 4:30 p.m. (Eastern Time). Register for this webinar from our events page. If Tuesday afternoon doesn't work for you, visit our archives page at your convenience any time after next Wednesday and download the webinar for viewing.

Profit and loss of Abercrombie & Fitch (ANF) put tree