Tag Team: GPS

 | Feb 26, 2013 | 9:50 AM EST
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Jill: Gap (GPS) is probably one of my least favorite stocks (not just for fundamental and technical reasons) but this retailer has not had a decent trend since maybe skinny jeans in the mid 2000s. It has a strong presence in North America and Europe, as well as dozens of stores in Asia and exploratory stores in Chile, Mexico, Egypt, and South Africa. 

In 2012, GPS returned a staggering 67% return. While the share price soared, the company's international operations delivered a disappointing 3% decrease in sales in 2012, adding to 2011's disappointing 7% decrease (maybe "not as bad" is rewarding?) With the company's big plans for 2013 focused on international expansion, I expect that international sales will continue to underperform and in the process, undermine GPS 2013 performance.

In 2013, GPS plans to go global, particularly in the large consumer markets of Brazil, Mexico, India, South Africa, and China. Yes, I love the emerging market theme, but for those companies that ALREADY have exposure to the regions. Diversifying a business through sales to international markets clearly makes sense. In practice, however, every new country means a new set of business licenses, laws, and other regulations, as well as arrangements with domestic partner companies and new market research, all with no guarantee of ever making a sale. In addition to the horrible product mix, GPS commands high prices for its brands in developing markets. So while that 67% return was impressive for 2012, I think the stock is going to come back down to reality because GPS has to actually execute on all those plans. I spoke more on the market overall, GPS and some other retail ideas on Clear Channel's Trade Network this Monday.

Skip: GPS is almost fully coiled. The last time it coiled was almost a year ago (late January 2012) when it was around the $19 level. Since then GPS has basically gone straight up, topping out last fall near $38. Since that top was put trading (dare I mention that word?) it has been slow but steady distribution for GPS shareholders. This type of distribution I label as the "boiled frog type" where the longs just don't seem to get the fact that the stock has dropped 15%+ from that months ago top. In other words the water in the pot was tepid to start but now tepid has slowly morphed to hot, ouch, and uh oh. The RSI for GPS is declining into bearish territory as I read that indicator. In addition the slow stochastic also reads bearish.

GPS will announce its last quarter's earnings performance on February 28, as well as closing the books on fiscal year 2013 which ended last month (January 2013). Both the last quarter and the year end results should show very good improvement over that of fiscal year 2012! In fact these results could grab headlines and deservedly so. However, stocks have a nice habit of eventually anticipating six months ahead when it comes to earnings performance, the past getting a tip of the cap but the what have you done for me lately crowd is soon heard after all the cheering ends.

While I am not a big bear on GPS, I do think it can continue to slowly test the hands (stomach) of the longs. That can possibly be the situation well into summer. Given this potential scenario, the trade tactic I prefer for GPS now is the in-the-money call calendar spread. It is designed to use decay as an ally while the underlying stock attempts to find its next basing/value level. Thus, the art of the trade for this tactic is found in the timing of when the current bearish decline might end, and the next bullish cycle might begin. Time both of those factors correctly and for a very low risk trade you can be nicely rewarded.

You should consider that this trade will be in play for possibly months from now, if not the entire year! Thus, that is another somewhat unusual factor to consider before executing the trade. One more additional risk factor is an early exercise for the short side of the spread if the stock was to move much higher in price before the shorted side expires.

Trades: Sell to open 3 GPS September 30 calls at $3.60 and buy to open 3 GPS January 30 calls for $4.30.

As always, we will monitor the trade on this site in the comments section below.

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