Options traders are the most bullish on Target Corp. in almost eight years as they bet the discount retailer will recover from an attack by hackers and an expansion into Canada that has mauled earnings.
Puts with an exercise price 10 percent below the shares cost 2.93 points more than calls betting on a 10 percent rally, according to three-month data compiled by Bloomberg. The price relationship known as skew reached 2.79 on Feb. 5, the lowest since July 2006. Target’s shares dropped to $55.07 that day, their lowest price in 20 months.
Online security concerns have pushed Target to a valuation discount to its peers. Traders buying bullish options are probably betting shoppers will return to the retailer, according to Matthew Lockridge, a Dallas-based fund manager at Westwood Management Corp. Target, scheduled to report its results on Feb. 26, was struggling to increase sales even before it was hacked due to competition in Canada.
“It remains a financially strong defensive retailer with a very good management team,” Lockridge, who helps manage about $18 billion including shares in Target, said by telephone. “The earnings they will report are going to have the brunt of the impact of the data breach and the continued investment in Canada, but that quarter is over. As we look into 2014 and 2015, we see a really bright fundamental picture.”
Target issued a statement six days before Christmas saying that hackers may have accessed data on 40 million credit and debit cards before the holiday season. The second-largest U.S. discount retailer lowered its sales forecast on Jan. 10, adding that the names, phone numbers, home and e-mail addresses of as many 70 million people were also taken in the security breach.
Analysts estimate that profit per share slumped 47 percent in the three months through January, the biggest quarterly decline since 2006. Earnings for the financial year slid 32 percent, making this the worst annual performance since at least 1987, according to projections compiled by Bloomberg.
Target’s shares have tumbled 13 percent since Nov. 21 when the retailer last reported results. The Standard & Poor’s 500 Index has gained 2.4 percent in the same period. The U.S. market was closed yesterday for a public holiday.
The stock trades at 12.6 times estimated earnings, while consumer-discretionary companies are valued at a multiple of 18.5, data compiled by Bloomberg show.
Target will probably increase its same-store sales over time because it has good relationships with its suppliers and different merchandise than its competitors, according to Nomura Holdings Inc. The brokerage initiated coverage of the company with a neutral rating on Feb. 12.
The company’s food business, accounting for almost one-third of 2012 sales, should continue to attract shoppers, Nomura’s Robert Drbul wrote. He estimated the shares would rise to $62 in one year, 11 percent above the Feb. 14 closing price.
A Commerce Department report last week showed that U.S. retail sales declined in January by the most since June 2012 amid bad weather and uneven progress in the labor market. The International Council of Shopping Centers predicts that chain-store sales will climb as much as 3.5 percent in February, while the National Retail Federation has said U.S. retail revenue will increase 4.1 percent this year.
Implied volatility, used to gauge the cost of options, for three-month contracts with an exercise price 10 percent below Target’s shares has climbed 11 percent to 23.29 this year, data compiled by Bloomberg show. That compares with a 14 percent gain to 20.35 for calls 10 percent above.
Molly Snyder, a spokeswoman for Target, did not return a phone call and an e-mail made after business hours seeking comment on options trading.
Faye Landes at Cowen & Co. in New York says that investors should err on the side caution and assume that the company puts its buyback program on hold while it counts the cost of upgrading its payment systems following the cyber attack.
“We expect the company to suspend its buyback, a key support for the stock, indefinitely,” Landes wrote in a Jan. 21 note to clients, downgrading the stock to underperform, the equivalent of a sell rating. “We cannot estimate the costs related to the credit breach, including replacement cards and terminals, legal and settlement fees, and doubt that Target will have visibility on these costs for some time.”
Target disappointed analysts when it posted profit for the third quarter of its financial year on Nov. 21. The troubles at its Canadian unit and the cost of opening 124 stores in the country since March combined to subtract 29 cents a share from quarterly earnings.
Earlier this month, John Mulligan, Target’s chief financial officer, apologized to U.S. lawmakers for the data breach and said the company would improve security by issuing chip-enabled cards to its customers.
The Chicago Board Options Exchange Volatility Index, the measure of expected volatility on the S&P 500 also known as the VIX, rose 2.2 percent to 13.87 at 4 p.m. in New York, snapping a seven-day streak of declines. Europe’s VStoxx Index fell 0.6 percent to 17.10.
Traders hold fewer bearish Target options than bullish ones. There were 144,664 puts outstanding on Feb. 13, compared with 168,065 calls, according to data compiled by Bloomberg. The put-to-call ratio fell to 0.82-to-1 on Feb. 7, the lowest since August 2012.
Among the seven most-owned Target options, five were bullish. January 2015 $60 calls, with an exercise price 7 percent above Feb. 14’s close, had the highest open interest, followed by March $57.50 calls, the data show.
“I’m seeing the hallmark signs of selling exhaustion,” Alec Levine, an equity derivatives strategist at Newedge Group SA in New York, said in a Feb. 14 interview. “Data breaches are not unique to Target; it is a cost of doing business in the 21st century. It does look horrible for Target, but this will pass, and the shift in skew is signaling that.”