Big Lots (BIG): Playing Deal Stocks with Option Spreads

There is no better feeling than being long call options and then having a takeover deal announced for your holding, resulting in huge gains, but sometimes potential deals are made public well before an official deal, and there are weeks, and often months, of large options trades positioning for an eventual deal. I am not talking about the every day takeover rumors that make the way around trading floors, chat rooms,twitter, and especially the laughable rumors cited on CNBC's Fast Money, as these never come to fruition 95% of the time. I am talking about when activist investors make it public that they are looking into an acquisition of a Company or a Company announces it is seeking a sale. A variety of strategies can be used to benefit from the price of the stock eventually surging on a deal, and also take advantage of the volatility and time decay in options. With some basic relative valuation analysis and looking at prior deal premiums, projecting a price is also not too difficult to allow for the construction of a profitable strategy.

In this particular case I am looking at Big Lots (BIG). While fellow discount retailer BJ's Wholesale (BJ) has often been mentioned in takeover reports lately with Leonard Green, famous for buyouts, releasing a 13D with a 9.5% stake in shares last July. The group is hot lately with Nelson Peltz's recent offer to buy Family Dollar (FDO) being rejected, so the value is seen in this group.

On February 7th, Bloomberg reported that Big Lots (BIG) is considering a sale, sending shares from $34 to up above $39. The Company was said to be working with Goldman Sachs on a sale. Raymond James feels that the Company could fetch a $54/share offer. Since the story on February 7th shares have been able to not only maintain gains, but climb to new highs with a $43.55 close on Friday. The price action dictates that an eventual sale is likely here.

Big Lots' shares trade 12.5X earnings, 0.66X sales and 14.2X cash flow. EV/EBITDA of 6.9, also a key metric looked at for potential takeover prices, is on par with BJ's Wholesale, but well below the 8.84 ratio at CostCo (COST).

Considering the recent move in shares since the report, it has hard to imagine a premium coming in for more than 20%, and a $50 price-tag seems most likely in my view.

There are plenty of opportunities in the options market to bet on an eventual deal occurring. On March 23rd I noticed one large opening trade that was a very interesting approach.

A trader bought 5,000 May $45 calls at $1.85 and sold 10,000 October $50 calls at $0.80, net $0.25 debit (small outlay), in the calendar ratio call spread. The same trade was put through for 975X1950 contracts earlier that day. This trade is looking for the deal to get done by May expiration, being long the May calls at the $45 strike, OTM, and not wanting to be left with 10,000 short October $50 calls after May expiration. The maximum profits of this trade comes with shares at $50, the perfect situation as the May calls are then worth $5 and the October $50 calls would be worth $0.00 (theoretically, although will hold some value until official closing of the deal and without another bidder coming in at a higher price). So, a deal at $50/share would result in the $0.25 outlay being worth $5, or a 1900% gain, turning $125,000 into $2.5 Million. The trade is also profitable above $45.25 all the way to around $55, where the spread would be worth $0 and the trader would lose the $125,000 outlay. A deal above $55 and the trader's losses would start to mount, but this seems unlikely given the valuation and average premiums paid in retail buyouts.

Another way to play for a buyout in the expected price range I have noted without needing a margin account (due to the naked short calls in the ratio spread) would be to buy the July $45/$50/$55 butterfly call spread at $1.20, a profit zone from $46.20 to $53.80, which would not have quite as big of a percentage gain, but still a great way to play the deal. The strategy view is provided below:



A riskier way to play that is also attractive is the May $47.50/$37.50 bull risk reversal, buying the $47.50 calls at $1.05 and selling the $37.50 puts at $0.95 for a $0.10 outlay, a leveraged long position.







***This is Not a Trade Recommendation***

15 Bullish Set-Ups for March 9th

ITW: Consolidation Breakout

NDAQ: Bull Flag - Break of $29 Key

CAKE: Looks Great on Break of $30, Trend Resistance

LMT: Channel Down to Support - Like Above $81

RL: Post-Earnings Consolidation, Nearing BreakOut

EMR: Riding 50 EMA - Could See Highs Soon

DD: Looks Excellent Above $55

CAT: Consolidation; Above $105

YUM: Clean Strong Volume Break to Highs

DHR: Bull Consolidation, Break of $52

SCHW: Heading Higher after Consolidating

INFY: Based, Bullish ADX Crossover - Look for Close Above 50 EMA

AN: Consolidating Above 20 EMA; Look for Break of 20 EMA

CNQR: Breakout, Bullish ADX Crossover

RBCN: High Short Float - Broke $25 Resistance
















After Scanning my Stocks that Have Liquid Options, Here are 15 Charts I Liked this Morning:

Silver (SLV) - Trading the Parabolic Move with Option Spreads

Silver (SLV) has been on an absolute tear and without getting into too many details of why, some of the reasons include:

1) Silver is the only commodity with both industrial uses and monetary value

2) Unlike Gold, Silver is Consumed and Needs to be Replaced

3) Silver Production Increases Can Not Meet Demand

4) There is a Massive Short Squeeze in Silver

Today at 11:19am there was a large options trade in Silver (SLV) with 7,000 April $35 calls bought at $1.54 and 14,000 April $40 calls bought at $0.38. The trade was not marked spread, but it sure looked like a ratio call spread, but regardless I thought I would take a look at that trade as a spread.

Silver closed at $34.70 and a simple view of the chart would show the measured move targeting $41 (Prior Breakout of $19 to Next Top of $30 Implies $11 Move past $30 Breakout). Silver officially gave me a bullish reading on January 31st at $27.39 based on the ADX DM+/DM- Crossover, and the ADX closed today at 32, the trend is still fresh and room to run, seeing as the ADX hit 53 in October before a mini correction. The ratio call spread would work nicely in this case, as it is also bearish volatility, and the move higher is likely to have at least one correction along the way.



Trade: Buy the April $35/$40 Ratio Call Spread 1X2 at $0.79 Debit (Trade Profitable Between $35.79 and $44.21)



The ratio spread does tie up some margin because you are naked short OTM calls, but this spread is a way to use leverage to turn $79 into $500 (on a close at $40 come April expiration), but does involve risks if Silver were to blow past $44. If you are not wanting to be fancy, just look to buy the April $36 calls at $1.25, because this rocket-ship has plenty of fuel in the tanks.

Costco (COST) - Option Trader Plays Earnings Via the Ratio Put Spread

Costco (COST) options were active ahead of earnings to be reported before the open tomorrow morning, call volume 4X daily average and put volume near 4X daily average. There were a couple large trades on the day, early in the day the March $75/$80 "Call Stupid" Spreads traded around 2,500 contracts, both legs pricing below the bid. The March $75 calls traded 5,401 and $80's traded 3,483 on the day, well exceeding open interest, fresh action that pushed March IV 12% higher. Also, back on February 22nd a block of 20,000 March $70 puts was rolled out to the July $70 puts, which remain in Open Interest.

Costco shares are now trading in a tight $73 to $75 range after finally breaking clear of the 2008 top. The $32B retailer trades 19.4X earnings, 0.4X sales and 21.17X cash flow, and should be boosted from gasoline sales. Costco is a superb operator and generally reacts well on earnings, but after recently topping out at $75 is could pull back to the 50 day EMA at $72.42 where it tends to bounce, but expect buyers to bring it back from that level. Shares made a bearish ADX cross on 2/25 and the downtrend does have potential to accelerate from here.

This brings me to the ratio put spread that traded today at 2:14pm on the CBOE. The trader bought the March $75/$72.50 1X2 ratio put spread for 1,500X3,000 contracts at a $0.05 debit. The trade is bearish volatility, but actually positive Delta (Delta 0.14), as the $75's will hold value if shares head higher while the $72.50's will rapidly lose value, and the spread will widen. The trader makes maximum profits with shares sitting on the $72.50 level come options expiration, and is profitable in the $70 to $74.95 range come expiration, although the trader would likely exit the trade early if the shares hang in the $75 range next week, the trade a positive Theta trade as well. The trade comes with Costco's IV at more than a 6 month high, which ran up 40% in the past 3 weeks. With a small $0.05 outlay the trader can bank big time percentage gains on this trade, and it is fairly low risk, only getting the trade in trouble if shares were smashed below $70, which seems unlikely for a well respected name trading at fair valuation. (The P/L View is Below Using ThinkorSwim's Analyze Function)



My chart of CostCo is Below along with IV, HV, ATR Wilder, CCI, and Relative Volatility Index (This Likely Looks Confusing, but Settings I Have Gotten Used To)




Time will tell if this trade works or not, but as long as it hangs in this $70 to $75 range, it should work well, and looks to be a great choice into earnings. Also note, ratio spreads like these are often hedging large equity positions, because you get more "bang for your buck" with this type of hedge into a stock-moving catalyst.

Corning (GLW) Case Study - The Importance of Following Options Flow

In the first three minutes of trade today I saw big blocks buying the February $22 calls in Corning (GLW) at $0.42, offer side buying and soon that swelled to 5,000 contracts (More than 8,000 traded by day end). Shares opened quietly but started to make a run soon after, sending the calls for $0.42 up to $1.15 just before 3pm, an easy trade for an option scalper, nearly a 200% gain intraday.



I've come to learn that often the hottest action in the first 15 minutes in the options market tends to be the best for day trading options, and this is just an example of something seen most every day where there are opportunities to flip options intraday for 100%+ gains, especially near option expiration when much of the premium has been sucked out of these names that have very liquid trading and $1 strike increments.

Weight Watchers (WTW): Insider Info into Earnings, or Just a Hungry Bull?

Weight Watchers (WTW) posted a slamming quarter this morning, the classic beat and raise, blowing away Street estimates. Shares are indicated to open higher by more than 11% this morning, light pre-market volume, but looks like it will be a big winner today.

On February 14th, Monday, I noticed very unusual action in the Weight Watchers (WTW) call options and put out the following note to subscribers:

"Weight Watchers (WTW) touching new highs today on big volume into earnings on 2/17 and call volume of 6,764 is 25X daily average, a block of 4,273 bought at $0.95 and more than 5,450 trading as opening buys in the February $45 calls, OTM with shares at $44 and Feb IV up 20% on the day. Put volume in non-existant and shares have been on quite a run on building volume lately, maybe due to the failure of all the diet pills with the FDA denying all parties. There was also substantial accumulation with big blocks of shares this morning. The $3.25B Company has also frequently been noted in takeover chatter, shares trading 15.9X earnings and 2.3X sales, not a bad value. Shares rose on 12/7 with BofA raising it to Buy with a $48 target. Weight Watchers has not been exactly blowing away earnings of late, but maybe the New Year brought about more business with obesity a continued concern in the US and abroad, although April tends to be the best month for shares."

Another 1,360 of these calls traded yesterday and the March $45/$50 calls also attracted some unusual activity.

Those $0.95 calls will be worth more than $6 today, more than a 500% return over the course of 3 days, and nominal more than a $2.15M profit.

Now that is a fat pay-day, but making a directional bet of that size the week of options expiration has me thinking someone had some insider information on the earnings number.

Whole Foods (WFMI): Reviewing A Successful Double Calendar Spread Earnings Startegy

Whole Foods (WFMI) was set to report earnings on February 9th after the close and I had a good feeling it would continue its momentum from strong earnings last quarter, and also felt the options market was not pricing in enough volatility, seeing it as a stock that had consolidated with tight Bollinger Bands and ready to explode. I was closely following the options activity leading up to earnings and although more than 10,000 March $50 puts accumulated the action looked to be hedging as all the large blocks of stock were being bought right alongside. Also, I was seeing accumulation in May $60 calls, far OTM calls that are seeing a positive move coming. On a fundamental basis, shares do trade at a premium to other grocers, but they should with the growth and ability to pass on rising commodity costs to a more affluent customer base. The Street was also seriously under-estimating Whole Foods with most price targets sitting below $50. I now see shares as fairly valued, trading at the 10 year average P/E of about 33X. Same store sales rose at an impressive 9.1% in the quarter, and there is plenty of room for expansion going forward.

Directional bets can be dangerous on big earnings movers so I went with a more neutral strategy despite my positive inclinations. I decided to have my clients put on the February/March $60/$48 double calendar spread at $0.87, selling the February $60 calls and $48 puts to buy the March $60 calls and $48 puts. I chose these strikes because I felt these front month options were the most "juiced" with premium and was also my target moves for a beat/miss. The strategy is effective especially with less than a week left until options expiration when the front month IV is at a wide spread compared to the next month out.

Whole Foods delivered a stellar quarter and shares shot higher, reaching highs of $60.94 and settling Friday at $59.67 on the close. I decided to take profits mid-day on Thursday closing the spreads at $1.32, a 51.72% gain overnight. Not the biggest return, but a great execution of a neutral strategy and using options to effectively trade earnings.

A diagram of the original strategy P/L is below (ThinkorSwim Analyze Chart):



For a look at some of my recent earnings previews and along with option trading strategies, most of which were a resounding success, please visit (Scroll to Bottom of page): http://optionshawk.com/index_files/optiontrader.html

Bullish Breakout from Today, Many Large Cap

CSX Corp (CSX)



3M (MMM)



Lamar Advertising (LAMR)



Consol Energy (CNX)



Helmerich and Payne (HP)



Moody's (MCO)



Statoil (STO)



Thomson Creek (TC)



Grainger (GWW)



Waste Mgmt. (WM)



BE Aerospace (BEAV)

Fresh Breakout Alerts that Triggered Today with Charts

NPS Pharma (NPSP) Triggered at $6.75 - First Target $7.50, Potential for Bull Flag Breakout, Good Volume



Aluminum China (ACH) Triggers at $23 - Target $27 on Ascending Triangle Break (Call Buying)



Analog Devices (ADI) Triggers at $31 - Ascending Triangle Breakout (Call Buying) - First Target $34 2008 Highs



Digital River (DRIV) Triggers at $32 - Breaks into Massive Gap (Call Buying) - Target Near $40



Calix (CALX) Consolidation Breakout - Recent IPO's in Tech Hot (Also Like MOTR, IL)



Tupperware (TUP) - Triggered at $44 (Already +$2) - Call Buying Later - Ascending triangle Breakout and Room to Run - Target $50



Johnson Controls (JCI) Triggered at $30.50 for Channel Breakout - Target $35 - Call Buyers Came in Later



Pharmasset (VRUS) - Triggered at $29 - Simple Resistance Breakout - Target $34 Resistance



Steve Madden (SHOO) - Triggered at $40 - Target $45



Stanley Black & Decker (SWK) Bull Flag Breakout, Developing - Target $65



Cognizant (CTSH) - Triggered $64.50 - Resistance Breakout - Target $70



Carribou Coffee (CBOU) - Triggered at $10.25 - Consolidation Breakout - Target $12



99 Cent Stores (NDN) - A Bit Late but Great 10 year Weekly - Gap Fill to $20



Carbo Ceramics (CRR) - Triggered at $83 - Major Resistance Breakout - Target $100



Estee Lauder (EL) - Triggered at $62 - Descending Triangle Breakout - Target $65