Bloomberg News

Staples Traders See Rally After Decade’s Biggest Drop: Options

October 21, 2011

Oct. 21 (Bloomberg) -- Staples Inc.’s biggest stock plunge since 2000 is luring bullish options traders, who are lifting bets to an eight-year high that the world’s largest office- supply retailer will rally.

There are 3.04 calls to buy the stock for each put and the ratio reached 3.21 on Sept. 19, the highest since June 2003, according to data compiled by Bloomberg. Open interest in options to buy the shares for $15 by January 2013 has jumped by 19,310 contracts in the past two weeks for the biggest gain. The stock rallied 1.1 percent to $14.89 today.

Investors are betting the Framingham, Massachusetts-based retailer’s rising sales and profit can reverse this year’s 35 percent decline even as demand for office supplies falls. The shares trade near a record low price-to-earnings ratio and have lost less than rivals Office Depot Inc. and OfficeMax Inc., which plunged 60 percent and 71 percent in 2011.

“The stock is relatively cheap, and we’re also having year-on-year earnings growth,” Liam Dalton, chief executive officer of Axiom Capital Management Inc. in New York, which oversees $1.8 billion, said in a telephone interview. “There are other industries where earnings are much more sensitive to the economic cycle, and this one has less sensitivity because they have a fairly predictable business model.”

Staples’s annual revenue has increased every year since at least 2001, according to data compiled by Bloomberg. Net income rose 19 percent in fiscal 2011 and will climb 11 percent and 6 percent in the next two years, according to analyst estimates compiled by Bloomberg.

Valuation Levels

The retailer’s shares trade for 11.3 times reported earnings, 14 percent less than the S&P 500’s valuation. The 22 percent discount on Aug. 10 was the lowest since December 2000, according to data compiled by Bloomberg.

Implied volatility for Staples options expiring in three months fell 14 percent from its 29-month high of 49.87 on Oct. 4 to 42.97 yesterday, according to Bloomberg data. During that time, the options price gauge fell 13 percent to 85.15 for Office Depot, while it slid 15 percent to 91.96 for OfficeMax.

Owen Davis, a spokesman for Staples, declined to comment on the options trading.

The VIX, as the Chicago Board Options Exchange Volatility Index is known, fell 10 percent to 31.32 today. It retreated 23 percent from Oct. 3 through yesterday. Implied volatility for the SPDR S&P Retail exchange-traded fund dropped 22 percent for three-month options in the same period.

Bullish Options

There are 144,489 existing Staples calls, compared with 47,404 puts. Bullish options make up the seven contracts with the largest open interest. The 39,079 outstanding $15 calls that expire in January 2013 closed at $2.50 on Oct. 19, meaning a buyer at that price doesn’t profit at expiration unless the shares exceed $17.50.

“Some investors are bottom-feeding in the group and they don’t want to take a position in the stock so they’re buying the calls instead,” Frederic Ruffy, a senior options strategist at WhatsTrading.com, a New York-based provider of options-market analytics, said in an interview yesterday. “The trend this year hasn’t been bullish, so they may be taking positions in longer- term calls expecting that trend to change in 2012.”

Sales of office supplies have stagnated as the U.S. unemployment rate remains above 9 percent, Matt Arnold, an analyst for Edwards Jones & Co. in Des Peres, Missouri, said in an interview yesterday. Price competition and continued layoffs by governments facing budget reductions also pose risks to Staples’s growth prospects, said Arnold, who recommends buying the shares.

‘Its Destiny Varies’

“Its destiny varies with the health of the business community,” Lawrence Creatura, who helps oversee $350 billion a Rochester, New York-based fund manager at Federated Investors Inc., said in a telephone interview yesterday. “The macro risks in Staples are linked to future business activity, and if for any reason we’re weaker in the future than is expected, then they could run into trouble.”

Staples posted a gain in back-to-school sales and has been able to pass higher prices to customers, Chief Executive Officer Ron Sargent said at a September conference sponsored by Goldman Sachs Group Inc. He also said that he expects more mergers and acquisitions in the industry.

The retailer, which has been adding electronics such as Amazon.com Inc.’s Kindle digital reader and expanding services to boost revenue, partnered with Martha Stewart Living Omnimedia Inc. last month to offer a line of home office items that would appeal more to women. Women make up about 60 percent of in-store customers, according to Demos Parneros, the company’s president of U.S. retail.

Block Trades

Calls accounted for 20 of the 25 largest Staples options block trades this month, according to data from Trade Alert LLC, a New York-based provider of options market data and analysis. The largest transaction was for 9,800 January 2013 $15 calls that changed hands on Oct. 10.

“You can see steady buying in those 2013 calls that’s been going on over time,” Ralph Edwards, director of derivatives strategy at Investment Technology Group Inc. in New York, said in a telephone interview yesterday. “The pressure would be off of Staples if there’s no double dip in the economy, so this is a long-term bet.”

January $17.50 calls have the second-largest ownership at 11,835 contracts. Staples hasn’t closed above that price since before May 18, when it plunged 15 percent for the biggest loss in 11 years after cutting its profit forecast and expansion plans for 2011 because of the slowing economic recovery.

“They’re clearly the best player and at some point consolidation will occur in the industry and employment will recover,” David Strasser, a New York-based analyst for Janney Montgomery Scott LLC who recommends buying the shares, said in an Oct. 11 telephone interview. “Then you could have a very strong stock.”

--With assistance from Matt Townsend and Courtney Dentch in New York. Editors: Joanna Ossinger, Nick Baker

To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net; Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net


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