Investors traded in-the-money calls in Kohl's KSS on Wednesday, possibly in anticipation of strong holiday shopping numbers from the retailer leading the way for a stronger 2011. For the most part, the retailer has enjoyed steady sales growth this year, posting same-store sales increases in all but two months of 2010. Most recently, November same-store sales grew by 6.1%, outpacing analysts' consensus view.
Stability on the sales front hasn't trickled down to the stock yet, as the shares are down a fraction year-to-date and up less than 7% in the past three months, underperforming the broader market. It is possible that a certain large-scale option trader is hoping the tide will turn over the next half-year or so.
Wednesday morning, a block of 5,160 July 45 calls traded for $10.15, which was near the ask price at the time of the trade. With open interest of just 21 contracts heading into the session, it is likely that these calls were bought to open.
At the time of this options trading, these calls had nearly $8.60 in intrinsic value and a delta of almost 83. At the same time, a block of 390,000 KSS shares changed hands for $53.58 per share.
There are a couple of ways to dissect this action. It could be the trader is “replacing” a long stock position with a long in-the-money-call. This would reduce the amount of capital required for a long delta position in the shares, along with reducing the downside to the premium paid if the shares would fall below the strike price. Alternatively, the trader may simply have shorted these shares in an effort to lower the delta risk of this trade. He may turn around and buy to close these shares, leaving only the long call on the tape. Third, if he leaves this as a hedge position, this becomes a volatility trade with expectations of increased volatility in KSS for the next seven months.
If the long call is left open, either as a replacement to long stock or after the short stock hedge is bought back, this turns into a bullish play. At expiration, the call will be profitable above the breakeven price of $55.15 (strike plus premium paid). Gains in a long call are theoretically unlimited above this point. Losses are limited to 100% of the premium paid and occur only if KSS is trading south of the 45 strike when the options expire.
In-the-money, longer-term call options are relatively conservative (when compared to out-of-the-money, shorter-term plays) but require more capital at the outset because of the intrinsic value already built into the option. In exchange for this higher premium, in-the-money calls, by definition, will typically have higher deltas. One way of interpreting delta is the percent chance the option has of expiring in-the-money. So by extension, higher-delta calls will generally have a greater chance for success.
While we don't know conclusively whether Wednesday's trader expects upside in KSS shares outright or in the stock's implied volatility, it is evident that he expects movement of some variety. And either or both of these factors might be impacted by whether or not KSS has a strong holiday shopping season.
Photo Credit: qnr
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