Traders Losing Faith Send Sears Bearish Bets to Record

Concern that Sears Holdings Corp. is running out of ways to halt a sales slump has driven bearish bets on the unprofitable retailer to a record.

The department-store chain that is reeling from nine straight quarterly losses has tumbled 32 percent from a high in May. The cost of bearish options versus bullish ones is near an all-time high reached this month, even as the company said it will generate cash by selling shares in Sears Canada Inc.

Shrinking sales and increasing losses have pushed Chief Executive Officer Edward Lampert, who is also Sears’s largest shareholder, into selling assets to raise cash. That strategy is nearing its end, and there are few signs the company will be able to turn around its operations, according to Matt McGinley of International Strategy & Investment Group.

“They’ve been burning furniture to stay warm,” McGinley said by telephone from New York. “Now they’re down to the last handful of things they can sell. We’re probably closer to the end at this point than we’ve been in a long time.”

Sears’s free cash flow in fiscal 2014 is negative $1.4 billion and hasn’t been positive since 2010, according to data compiled by Bloomberg. On Aug. 21, the Hoffman Estates, Illinois-based company reported a quarterly loss of $5.39 a share, its biggest since the fourth quarter of 2012. Analysts estimate losses will continue through fiscal 2019.

Sell Shares

ISI recommends investors sell shares of Sears and projects the stock will plunge to $16 in a year. It sank 15 percent to $25.79 at 12:13 p.m. in New York as people with knowledge of the matter said three of the biggest insurance firms for Sears’s suppliers are seeking to reduce coverage, prompting at least one medium-sized vendor to halt shipments to the retailer.

The retailer is planning a rights offering of Sears Canada shares to generate as much as $380 million in cash and decrease its stake in the unit. It said in May it would consider selling the Canadian business after cutting its stake in the division to 51 percent from 95 percent in 2012.

The company spun off its Lands’ End clothing division in April and its smaller-format Hometown & Outlet Stores in 2012. It has also sold leases and said it’s considering options for its auto-service centers and warranty business.

Last month, Sears announced that Lampert’s hedge fund, ESL Investments Inc., would loan it $400 million in a transaction secured by a first lien on 25 stores.

Record Spread

Options hedging against a 10 percent decline in Sears shares cost 19 points more than calls betting on a 10 percent gain on Oct. 2, according to three-month implied-volatility data compiled by Bloomberg. That was the widest spread since at least 2004, and up from minus 0.2 in July. The measure, known as skew, had an average of 4.1 in the last three years.

Bearish Sears contracts outnumbered bullish ones on Oct. 3 for the first time since January 2013, according to data compiled by Bloomberg.

Chris Brathwaite, a spokesman for Sears, declined to comment on the options trading in an e-mail.

The rights offering of Sears Canada may have boosted some investors’ outlook, according to Jim Strugger of MKM Holdings LLC. Bruce Berkowitz, founder of Fairholme Capital Management LLC, Sears’s third-biggest shareholder, reported the purchase of 49,200 shares of the retailer on Oct. 2. Berkowitz was named Morningstar Inc.’s domestic stock mutual fund manager of the decade in 2010.

CDS Drop

The upfront cost of credit-default swaps insuring $10 million of Sears debt for five years dropped to $3.43 million from a 2 1/2-year high of $3.95 million Sept. 29, according to CMA. That’s in addition to $500,000 annually. The swaps, which insure bondholders against nonpayment, typically fall as investor confidence improves.

“It’s notable that five-year CDS has come in pretty sharply over the past week,” said Strugger, derivatives strategist at MKM in Stamford, Connecticut. “The Sears Canada transaction may improve the creditworthiness of Sears Holdings, even while the increasing options put/call open-interest ratio and steepening put skew indicate risk to the equity.”

Investors have pushed the short interest on Sears to 12 percent of shares outstanding, the highest level since February 2012, according to Markit data. Mitch Rubin of RiverPark Capital Management LLC said his firm has held short positions in Sears in the past, and that the shares are now difficult to borrow.

Sears is the third most-expensive stock to short in the Russell 1000 Index. The cost to borrow shares is rated a 7 by Markit, with 10 being the most expensive level on the research firm’s scale. The average for the companies on the gauge is 1.1.

“Clearly there’s a concern about the company’s liquidity if it’s gotta borrow from its sponsor,” Rubin, the New York-based chief investment officer of RiverPark, said of ESL’s loan to Sears. His firm manages about $3 billion. “The history of retailers who lose their relevance is not a good one. Very few regain their relevance.”

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