### Sears Capital Structure Mispricing?

Sears has two holding company debt maturities that are interesting to watch: there's an October 2018 maturity trading at 82 cents (~50% YTM) and then the 8% note due December 2019 that's trading at about 35 cents (>80% YTM).

Meanwhile, the equity market capitalization is $330 million. And there are options traded out to January 2020, which is after the 2019 debt maturity. For example, the $2 strike put which has traded for $1.00 recently.

So if there's a capital structure mispricing, it should be possible to buy bonds and puts and come out ahead for the likely scenarios (restructuring vs survival) for the company.

Imagine that for every bond you bought
6.33 of the put option contracts. Given the current prices of $1 for the put option and $350 for each
bond, there would be four possible scenarios that I can see:

First, if the company is able to repay in December 2019 but the stock is trading for more than $2 and
the options expire worthless, the trade would make $650 in bond appreciation and $136 in interest per bond but
lose the $633 of put premium on the offsetting hedge. That is a net profit of $153 on the
current combined value of $983 per bond for a gross return on investment of 16 percent.

In the second scenario, if the company liquidates, it is quite possible that these bonds would have no
recovery as they are subordinate to all of the company's other debt. However, in that case we would
expect the stock to be worthless. If the $2 put options recovered full strike price, they would be worth
double their current $1 value. That would be a profit of $633 per bond, minus the current $350 bond
value, leaving $283 of profit on the current combined value of $983 per bond. Depending on when the
company liquidated, bondholders would also receive some number of semiannual interest payments.
The gross return for this scenario, not counting any interest received, would be 29 percent.

The third scenario is one where other creditors of the company (e.g. controlling shareholder and major
lender Eddie Lampert) take their lumps in a massively dilutive out-of court restructuring that sees them
exchanging their debt for practically all the equity. In this scenario, supposing that the stock declined to
50 cents and a bondholder held out from the exchange and received full payment, they would make $316.50 of
profit on put options, $136 of interest, and $650 of bond appreciation for a total of $1,102 on the
current combined value of $983 per bond.

A fourth scenario is one where something goes wrong that we cannot foresee. The question is whether Eddie and Sears have any way to wriggle out of the three scenarios above?

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