Options Corner: Trump Blinking First On Tariffs Presents An Opportunity For Best Buy

Under ordinary circumstances, investors would be prudent to avoid large-capitalization firms that suffer double-digit-percentage losses over a single day, as was the case with Best Buy Co Inc BBY earlier this week. Unsurprisingly, anxieties related to President Donald Trump's tariffs against key economic partners weighed heavily on Best Buy’s stock. Still, for intrepid speculators, the political drama could offer a high-risk, high-reward opportunity.

On Tuesday, Best Buy stock predictably opened the session from a massive gap-down position. Earlier, President Trump announced that he would impose a 25% tariff on imported goods from Mexico and Canada. As well, he announced a doubling of tariffs of China-exported goods to 20%. In response, affected nations stated their intentions to take retaliatory measures, thus raising the prospect of an ugly trade war.

For Best Buy, the matter is extremely consequential. On Wednesday, management revealed upbeat fourth-quarter sales, contributing to a lift in Best Buy stock. Affirming the positive side of the spectrum, Goldman Sachs analyst Kate McShane highlighted “increased demand from replacement cycle and innovation driven purchases" as compelling catalysts. Nevertheless, Telsey Advisory analyst Joseph Feldman warned that Best Buy sources about 60% of its products from China and another approximately 20% from Mexico.

Despite the high-level rumblings, cooler heads may prevail. Amid the back-and-forth, President Trump signaled a willingness to negotiate terms. Shortly thereafter, the president walked back his tariffs on Mexico and Canada by pausing levies on imports which were impacting domestic automakers.

Earlier today, President Trump announced on social media that most products from Mexico will receive an exemption from tariffs until April 2. In other words, the administration is realizing that being the sheriff is not as easy as it looks on TV. That might be good news for Best Buy.

Speculative Winds Favor An Optimistic Outlook

As stated earlier, huge losses are not ideal for large enterprises. These behemoths take time to build their valuations. So, when a massive implosion occurs, it's usually a sign of a fundamental vulnerability. However, with Best Buy, the picture is far more nuanced.

Using share-price data from January 2019, a position entered at the beginning of the week has a 50% chance of rising by the end of it. Over an eight-week period, this baseline probability rises to 53.33%. Under the positive scenario, Best Buy features a median return of 10.43% after the eight-week period has passed. Under the negative scenario, Best Buy stock incurs a median loss of 7.77%.

Under dynamic conditions — in this case, a one-week loss of 10% or worse — the long odds in the subsequent two weeks come in at 62.5%. Over an eight-week period, the odds are 50/50. Following this nearly two-month period, the median return is 14.19% while the median loss is only 4.17%.

To use a musical analogy, it's as if the notes on a composition were transposed up a whole step. That's why even if the eight-week probabilities are 50/50, the overall winds still favor bullish speculation. Add in the fundamental likelihood that the Trump administration will potentially back down from tariff threats and Best Buy suddenly looks more enticing.

Now, the caveat to the above analysis is that while Best Buy is losing about 12% in the past five sessions, such volatility is rare. One-week losses of 10% or worse have happened only eight times since January 2019.

Still, there is evidence that investors buy the dips in Best Buy. For example, there have been 22 times when the security has lost between 5% and 10% in a one-week period. Over the next eight weeks, the long odds stand at nearly 73%.

Engaging the Retail Stare Down

Ultimately, BBest Buy represents a political stare down, specifically as it relates to tariffs. Despite the blunt rhetoric, the speculation is that the Trump administration will quickly realize that supply chains are global. Because of this framework, no country can escape unscathed from a trade war.

With that in mind, there are two approaches for Best Buy. The first one is the simple, straightforward method — simply acquire the stock in the open market. Again, double-digit losses are rare for the retailer and the backdrop of positive fundamentals (in the form of stepping away from tariffs) could boost shares.

For those who want to wager on the possible near-term spike in the stock, such traders may want to consider the 80/82 bull call spread for the options chain expiring March 21 (roughly two weeks from today). At time of writing, this transaction involves buying the $80 call (at a $163 ask) and simultaneously selling the $82 call (at an $85 bid).

In the above transaction, traders use the short call proceeds to partially offset the long call debit, leading to a cash outlay of $78. The speculation is that BBY will reach $82 or above at the March 21 expiration date. If so, the maximum reward comes out to $122, a payout of over 156%.

According to E*TRADE's options calculator, there's only a 32.54% chance that BBY stock will close above $80.79, the breakeven price of the March 21 80/82 bull spread. However, based on the dynamic conditions of a two-week follow-through from extreme volatility, the odds may be much higher than advertised.

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