Betting Against An Overbought Retailer

Maybe The Fed Needs To Hike Rates Again

That was our first thought when we saw that shares of a retailer had more than doubled in price since it missed earnings last quarter, ostensibly because one of its competitors was bought out. Our second thought was that it highlights the need to look at numbers in context sometimes, rather than always adhering to the same quantitative approach--even if that approach has done well for us recently, as we noted last week ("Waiting For The World To End").

Waiting For The World To End

How we made money in the meantime this week. $ULTA $FTCHhttps://t.co/TbXImBZeVg

— Portfolio Armor (@PortfolioArmor) December 1, 2023

These were the results of the trades we placed with that approach last week: 

Options Trades

1. Call spread on Kroger (KR 2.52%↑). Entered at a net debit of $0.41 on 11/29; exited at a net debit of $0.57 on 11/30. Profit: 39%.

2. Call spread on Dollar Tree (DLTR 0.00%↑). Entered at a net debit of $0.45 on 11/28; exited at a net credit of $0.80 on 11/29. Profit: 78%.

3. Put spread on Farfetch (FTCH 0.00%↑). Entered at a net debit of $0.29 on 11/28; exited at a net credit of $0.48 on 11/29. Profit: 68%.

4. Call spread on Snowflake (SNOW -3.42%↓). Entered at a net debit of $2.30 on 11/29; exited at a net credit of $4.74 on 11/30. Profit: 106%.

5. Call spread on Ulta Beauty (ULTA -0.94%↓). Entered at a net debit of $2.40 on 11/30; exited at a net credit of $4.95 on 12/1. Profit: 106%.

Let's recap our approach first, and then explain why we're deviating from it in this case.

Our Ten Signals For Evaluating Earnings Trades

We use these ten signals for evaluating earnings trades: 

• LikeFolio’s earnings score based on social data. The higher the number, the more bullish, the lower (more negative) the number, the more bearish.

• Portfolio Armor’s gauge of options market sentiment.

• Chartmill’s Setup rating. On a scale of 0-10, this is a measure of technical consolidation. For bullish trades, we want a high setup rating; for bearish trades, a lower one.

• Chartmill’s Valuation rating. On a scale of 0-10, this is a measure of fundamental valuation incorporating common rations like P/E, PEG, EBITDA/Enterprise Value, etc. For bullish trades, the higher the better the Valuation rating the better; for bearish trades, the reverse.

• Zacks Earnings ESP (Expected Surprise Prediction). This is a ratio of the most accurate analyst’s earnings estimate versus the consensus estimate.

• Zacks Ranking. A number from 1 to 5 with 1 representing their 5% most bullish stocks, 2 representing their next 20%, 3 the middle 50%, and so on.

• The Piotroski F-Score. A measure of financial strength on a scale from 0-9, with 9 being best.

• Recent insider transactions.

• RSI (Relative Strength Index). A technical measure of whether a stock is overbought or oversold. We’re looking for RSI levels below 70 for bullish trades and above 30 for bearish ones.

• Short Interest.

For most of those signals, we give a numerical rating from -2 (very bearish) to +2 (very bullish), and for each stock we evaluate each week (not just the ones we place trades on), we enter the data above in a spreadsheet, and at the end of the week, we record each stock’s 5-day return.