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A Play with a 90% Chance of Success

May 15, 2014 | About:

Make money with Kohl's, the "King of Sideways."

Would you take a bet that has a better than a 90% chance of winning? Would it make you feel better if you got to hold the stakes until the wager had played out? Those odds are available right now for put sellers on the shares of high-quality discount retailer, Kohl’s (KSS).

Most stores suffered in the first quarter of 2014 due to bitter cold associated with the December 2013 through April 2014 Polar Vortex. Many people chose to simply stay home rather than fight the elements. Snow and ice removal costs also impacted earnings.

Fellow discounter Wal-Mart said weather-related expenses knocked 3 cents a share from its fiscal first quarter. Kohl’s chimed in with similar commentary when management announced earnings that were a couple of cents lighter than estimates. That hopefully non-recurring drain shouldn’t detract from either company’s long-term prospects.

(After the close on May 15, Berkshire Hathaway (BRK.A)(BRK.B) announced it had boosted its already hefty stake in WMT during the March quarter.)

Kohl’s garners high grades in three out of four of Value Line’s most important company metrics. It fell slightly below average in terms of "price growth persistence," Value Line’s gauge of how well a stock performed long term versus its full 1700-company main research universe.

The beauty of put writing is that you don’t even need the underlying stock to go up in order to make money.

KSS has been in a fairly tight trading range during the past four years. The shares have gyrated around the $50 mark even as they went from paying no cash dividend to the present quarterly rate of $0.39. At Thursday’s closing quote of $52.21 KSS provides a well-covered current yield of 2.98%.

KSS increased its payout during each of the four years since cash distributions were initiated. In a ZIRP world Kohl’s yield provides support in the same way that utility company dividends do. At a historically typical 2.5% yield KSS shares would trade closer to $62.

The light first quarter means Kohl’s may not achieve Value Line’s 2014 estimate. It is still expected to earn at least $4.05 to $4.15 per share. KSS’s average P/E, in the six years from 2008 through 2013, was 13x. A return to a normal multiple would support a $54 target price.

Kohl’s looks somewhat undervalued. Selling KSS January 2016 $50 puts brought in $6.30 per share today with KSS trading for $52.41. Put writers’ commitment is to stand ready to purchase KSS for a net price of $43.70 ($50 strike price, $6.30 put premium).

Maximum profit will come if KSS closes at $50 or better on the Jan. 15, 2016, expiration date. Put sellers could then pocket 100% of the $630 per contract received without needing to buy anything.

The chart shows how infrequently Kohl’s has ventured under this trade’s break-even point. When it did broach that area, it never lingered long. One of these days Kohl’s will beat its very low expectation bar and the stock will take off.

The very dicey J.C. Penney (JCP) surged more than 16% after hours today simply by reporting a slightly lower than expected (d$1.16) quarterly loss. J.W. Nordstrom (JWN) was ahead by 8.6% as of 6 p.m. after exceeeding analyst views.

KSS appears to be low-risk at $52.21. Selling puts with a sub-$44 break-even works to magnify the chance for positive results.

Disclosure: Short KSS January 2016, $50 puts, Short WMT January 2016, $70, $77.50 & $80 puts

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.gurufocus.com/peter_lynch.php
http://www.TalkMarkets.com
http://www.MutualFunds.com

Visit Dr. Paul Price's Website


Rating: 5.0/5 (4 votes)

Voters:

Comments

pravchaw
Pravchaw premium member - 7 months ago

Great suggestion Dr. Paul. I like selling puts as time works for you. Do you typically trade LEAPs?

Dr. Paul Price
Dr. Paul Price premium member - 7 months ago

I trade LEAPS often.

Many times I end up closing well before expiration, while pocketing the lion's share of the premiums anyway.

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