Why No One Shops at Macy’s
So the one thing we didn’t figure on when doing the Macy’s (M) trade was that the company is actually bovine defecation outlet posing as a department store chain. When this reality hit, the stock dropped quite a bit more than the straddle price predicted. Granted, the options market didn’t know that Macy’s has actually been overrun by commie nazi zombies.
More seriously though, the trade set up was a very good one, but clearly there will be times when reactions to earnings are extreme and go beyond the range of the double calendar/double diagonal. Generally speaking though, the straddle price does a good job of estimating the limit of an earnings move.
In the event of busted calendar/diagonal, there are a few ways to manage the trade:
- Roll the spread – This is highly unlikely because the IV/HV relationship has usually compressed too much to make the same type of trade attractive
- Close the shorts – Also not that common, but if something crazy happens (accounting fraud! the CEO is actually an extraterrestrial being! the company changes its name to Pets.com!) then you could let your longs ride.
- Wait – Depending on the severity of the move and the subsequent straddle pricing, you may want to wait the trade out and see if it returns to your happy range before expiration.
- Cut your losses – If the move is steep enough, or you have reason to believe no reversal will come prior to expiration (based on technical analysis and what not) then it may make sense to take your loss and move to bigger and better things.
Of course we expect to have substantially more winners than losers, and given the limited risk inherent in these types of trades, cutting losses is probably the correct choice in most cases. With Macy’s, the stock drop was still within range of our short strikes (given the straddle price) so it was worth sitting on another day. Once the stock price closed below $32 yesterday and on the lows, it was a pretty good signal to close the trade in the morning.
Besides, who shops at Macy’s anyways? I mean, besides zombies.