Tuesday, December 27, 2011

Short Volatility Idea: Sears Holdings ($SHLD)

A correspondent writes in with the following short volatility trade idea to take advantage of the Sears Holdings obliteration today:

Sears stock is getting crushed after a lackluster holiday season. I think the thesis is intact (cashflow is positive). . .

You can sell $30 strike puts for Jan 2013 for $11 . . . this means you are only risking $19 (if put the stock, that would be your cost). Your return for 13 months if the stock stays above $30 per share is more than 50% of the $19 you have at risk.

At a stock price of $19 the equity value would be about $2 billion . . . . The company has been buying back $500MM-$1billion of stock per year, so either it never gets this low, or the public float rapidly disappears. Lampert, his hedge fund, Berkowitz & Tisch own 80% of the company already (Berkowitz owns 15% and could face redemptions though). Any way you slice it, the public float is only 20% of the shares or about $750 million worth at the current price ($35 per share). If it goes below, the public float could be bought in pretty easily. They have $3 billion undrawn on the revolver (only $500MM currently drawn). The company has only $1.5 billion of bonds outstanding and they don’t come due until 2018.

The real kicker is that 10% of the stock is sold short. This is half the public float! The company can easily buy back 10% of their stock at these prices (less than $400MM) and the shorts will need to cover a further 10% of the stock . . . this account for the entire 20% public float.

Even if Berkowitz’s fund was forced to cough up an additional 5% of the company, this looks very asymmetrical. The options trade is much more asymmetrical because the stock is hard to borrow (because heavily shorted) so the puts are artificially expensive – probably priced 50% higher than they would be otherwise.

Volatility is also bid up today due to the big price drop. I don’t see many ways to lose here (the stock would have to fall to below $19 despite huge buybacks which have been steady since the stock was triple here, and a huge short interest that is almost sure to get squeezed), and the (limited) upside is more than 50% for a year . . .
Sears is a total dog. But, this could work...


Stagflationary Mark said...

Sears is an ongoing joke on my blog. The reason is in the comments. Check it out! ;)

May 8, 2008
Our Pillars of Retail Strength

I can't believe the previous comments are supposed to be taken seriously. First off, Eddie Lampert was recognized as a whiz a decade before buying Kmart. Second of Lampert is still a whiz his return on Kmart and on Sears even with the recent decline beats the market hand over fist.

Either you guys are joking or you like to buy high and sell low. Not my style. Lampert and Sears will prove to be fantastic investments over the next 10 years. Over the next 10 minutes? who knows and who cares?
- Anonymous

It's been 3 1/2 years. Just 6 1/2 years go to.

SHLD price then: 93.45
SHLD price now: 33.38

Buy high, sell higher! ;)

Stagflationary Mark said...

Here's my update.

Sears: The Joke that Keeps on Giving

CP said...

Yeah, that was a huge decline today!

I think the short put idea is not terrible, given the ownership dynamics.

Stagflationary Mark said...


You could very well be right. Shorting Sears does seem like a crowded "obvious" trade right now.

Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected. - Soros