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This Trade Could Make You 6X Shareholders' Returns

 December 04, 2012 09:24 AM

Traders are not always rational, and that statement seems to be especially true during earnings season. Millions, and at times billions, of dollars in stock market value are often lost in seconds when a company misses analysts' estimates for earnings by a small amount.

When apparel and footwear maker VF Corp. (NYSE: VFC), which owns brands like North Face, Lee and Wrangler, announced its quarterly results a few weeks ago, the company met analysts' earnings estimates but missed on the revenue side. The price sell-off that small revenue miss sparked looks like it was irrational when the earnings and outlook for the company are considered.

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In October, the company reported that its third-quarter earnings jumped 23%, to $3.52 per share, from the year-ago quarter, about 3 cents above the consensus forecast. The company also raised its guidance for the full year and raised its dividend by more than 20%. Unfortunately, VFC missed revenue expectations and reported that sales grew 11% to $3.1 billion from the year-ago period, missing analysts' expectations by 0.01%.

On the morning of the report, VFC gapped down, and had declined about 8% in the week after the report. Traders took more than $1.5 billion off the market cap of VFC because its revenue fell $20 million short of estimates. Since then, traders seem to be reassessing the company. VFC has formed a base during the past month and looks like it is ready to move higher.

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VFC has now moved back to the resistance level formed by the downside gap. The stochastics indicator offers another reason for bullishness on the daily chart shown above and the weekly chart (not shown). It seems likely that traders could push VFC back to its 52-week high near $170 before the next earnings announcement, which is due in February.

Buying the stock near the recent price level at about $162 would result in a 5% gain if VFC does set a new high. Although that is an acceptable rate of return for a three-month holding period, the high price of the stock means we would need to commit a large amount of capital to profit from that move.

Rather than buying 100 shares of VFC for more than $16,000, we could use February $150 call options to participate in the trade with less than 10% of that amount. These calls would be worth at least $20 if VFC reaches $170. They are currently trading at about $14.20, which offers a potential gain of 41%.

The risk on the trade can be limited to about the same dollar amount whether the stock or options are used. Traders buying VFC should use a stop-loss of $155, risking about $7 per share. That same amount of risk, about $7.50 per share, works well with the February options.

VFC has a large collection of name brands and has leveraged a growing product line into steady earnings growth. This is a stock that could be attractive to long-term investors.

In their last earnings conference call, management told investors to expect long-term earnings growth to average about 12% a year going forward. The stock also provides a dividend yield of about 2%. Long-term investors may consider the recent sell-off to be a buying opportunity, and this trade would benefit in the short term from their buying, which would drive the price up.

Action to Take --> Buy VFC at the market price. Set stop-loss at $155. Set initial price target at $170 for a potential 5% gain in three months.

Buy VFC Feb 150 Calls at $15 or less. Set stop-loss at $7.50. Set initial price target at $20 for a potential 33% gain in three months.

This article originally appeared on TradingAuthority.com:

This Trade Could Make You 6x Shareholders' Returns

-- Amber Hestla-Barnhart

Amber Hestla-Barnhart does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.


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