You don’t have to be a market guru to understand that discount retailer Dollar Tree (DLTR) faces significant challenges. A little over a year ago, I remarked that historically, businesses like DLTR stock should benefit from economic troubles. When consumers tighten their wallets, dollar stores become more attractive. Unfortunately, Dollar Tree’s margin-killing price cuts and promotions hasn’t boosted profitability, and in fact quite the opposite has occurred.
The retailer’s latest financial results served to crater DLTR stock. For the second quarter of Fiscal 2024, Dollar Tree posted earnings per share of 67 cents. However, this figure badly missed the consensus view of $1.04. On the top line, the discount specialist only rang up $7.38 billion in sales, falling short of the expected print of $7.49 billion. To top it off, forward guidance also disappointed.
It’s possible that the bad news has now been baked into the security. To be clear, I’m not suggesting that Dollar Tree is on the verge of a permanent recovery. However, for short-term speculators, there could be a profit opportunity based on the market’s natural ebb and flow. On that note, I am short-term bullish DLTR stock as a quick scalping opportunity.
Grabbing a Discount on DLTR Stock
As stated above, Dollar Tree is suffering from steep financial woes that will likely take years to address. At the same time, DLTR stock has lost over 50% of its equity value since mid-March. Without the emergence of another negative catalyst, though, it’s possible that the shares will avoid a continued slide. In fact, momentum has recently favored the bulls. In the past month, DLTR stock has gained almost 7%.
Against this backdrop, a short-term bullish position may be appropriate. Aside from the ebb-and-flow argument, the options market in particular sees forward movement fading relative to historical norms. Implied volatility (IV) currently sits at 42.41%, well below the historical volatility (HV) level of 86.22%. These stats indicate that forward movement may be muted. And because of that, options pricing is at a relative discount.
Investors ought to be on the lookout for whatever opportunity the market is offering. With option premiums muted, traders have an incentive — all other things being equal — to deploy a debit-based strategy. Specifically, a bull call spread appears enticing as this setup offers a discount to the debit paid on a straight call option.
Explaining the Core of the Bull Call Spread
Under a straight call purchase, a trader buys the right (but not the obligation) to acquire the underlying security at the contracted strike (exercise) price. However, the trader must pay a premium (i.e. the debit) for this right. The underlying security must rise to the call’s strike price plus the premium paid, by expiry, for the trade to break even. For a relatively high-priced security like DLTR stock, buying calls can be expensive.
To help mitigate this cost, optimistic speculators can consider a bull call spread. Half of the strategy is exactly the same as a straight call: buy a call option of in the hopes that the underlying security rises. However, with a call spread the investor simultaneously sell a call option at a higher strike price (for the same expiration date). The investor will receive credit from this higher-priced call option sale, reducing the overall debit paid.
Call spread traders enjoy another benefit. Since the credit from the short call offsets some of the cost of the long call, the breakeven price is also lower. In the case of the DLTR bull call spread I’m presenting, the stock wouldn’t need to rise as much for the trade to be profitable. It’s true that the maximum reward is capped using a spread strategy.
Looking at One Risk-Controlled Trade for Dollar Tree
Let’s assume that an investor believes DLTR stock has enough in the tank to pop up 6% by mid-November. That expectation would correlate to a share price rise to ~$75, which doesn’t seem unreasonable given DLTR stock closed near $76 on September 18. Rather than buying a straight call, an investor may want to consider the benefits of a bull call spread structure.
Those bullish on DLTR stock can buy the $70 November 15 call at an ask price of $5 per contract (as of last Friday). At the same time, the investor could sell the $75 November 15 call (which had a bid of $2.64). The difference between these two numbers results in a net debit paid of $2.36 per share ($236 per contract). That’s the most an investor can lose in this trade. However, if the market moves in their favor, a maximum reward of $2.64/share is possible ($264 per contract). To generate the maximum reward, DLTR stock must be at or above $75 at expiration. Notably, the breakeven price for this trade is $72.36.
If the investor had simply bought the $70 November 15 call straight up, their breakeven price would be $75. To receive the same $2.64/share max reward as the bull call spread could, DLTR would have to shoot up to $77.64. Those are big differentials, which is why the options spread is so appealing in my opinion.
Wall Street’s Take on Dollar Tree
Turning to Wall Street, DLTR stock has a Moderate Buy consensus rating based on eight Buy ratings, 14 Hold ratings, and one Sell. The average DLTR price target is $84.00, implying nearly 20% upside potential.
The Takeaway: Mark Down Your DLTR Stock Call Options
Discount retailer Dollar Tree may be courting trouble but in the absence of additional bad news, it’s possible that most of the bad news is already baked into the DLTR stock price. If so, a debit-based long strategy called a bull call spread may be appropriate. Thanks to the structure of this trade, an investor acquires a call option at a discount via income from a simultaneously sold call option at a higher strike. This setup also allows for a higher chance of profitability, making it extraordinarily compelling.
