The total risk is limited to $2.50, which the trader will lose if SHLD is below $62.50—so this trade has the potential to return 300% on investment. However, this is definitely a speculative play, considering that SHLD was trading at $47.30 at the time of the trade. This means that the stock would have to rise by 32 percent for this trade to be profitable.
The problem? Sears is not a profitable company, and does not expect to be one anytime soon —making a 32 percent rally in the stock unlikely without a major change. Since its merger with Kmart in 2005, Sears has seen revenues and profitability decline. Free cash flow has been negative since 2010, and consensus expectations are for the losses to continue through fiscal 2015.
CEO Louis D'Ambrosio was leading the turnaround attempt, and made progress last year with the closure of 100 unprofitable stores, and the spinoff of Sears Outlets. However, he recently announced that he would be stepping down, and will be replaced by Chairman of the Board Edward Lampert. This abrupt leadership change could stall the momentum the Sears turnaround recently gained, and it certainly increases uncertainty over the company's future.
Next Thursday, Sears will report earnings, which will be the most important near-term catalyst for the stock. It will also give the new CEO a chance to speak to investors, and explain what the company's strategy will be going forward.
To be willing to put this trade on, you must believe in Sears management and you have to think that they will return the company to profitability. Recent 13F filings show that the Fairholme Fund's Bruce Berkowitz added to their long position in Sears, so at least we know that there are some believers out there.
These trades are a little too speculative for my investors, so I hold no positions, but there is certainly an interesting story that continues to develop at this company.