American Eagle Outfitters Inc. (NYSE: AEO) stock is down today after economic data released this morning shows that service sector growth is slowing, but still positive, which was more or less in line with expectations. Reactions to this news on Wall Street are negative, because if the numbers aren't below expectations, we may not see any further rate cuts from the Fed any time soon, as some investors have been counting on. If you think this stock won't be rising too far in the coming months, then it could be a good time to look at a bearish hedged play on AEO.
After hitting a one-year high of $34.80 in January, the stock slipped to a one-year low of $21.46 in August. This morning, AEO opened at $25.60. So far today the stock has hit a low of $24.77 and a high of $25.60. As of 11:00, AEO is trading at $25.11, down $0.44 (-1.7%). The chart for AEO looks neutral but improving, while S&P gives the stock its highest 5 STARS (out of 5) strong buy rating.
For a bearish hedged play on this stock, I would consider a November bear-call credit spread above the $30 range. A bear-call credit spread is an options position that combines the purchase and sale of call options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. For this particular trade, we will make an 11.1% return in 4 months as long as AEO is below $30 at November expiration. American Eagle would have to rise by more than 19% before we would start to lose money.
AEO has not been above $30 since April, and has shown some resistance around $27.50 recently. This trade could be risky if consumer spending shrugs off the poor economic data we have been seeing recently, but even if that happens, this position could be protected by the resistance the stock formed around $27.50 where it has topped out in July.
Brent Archer is an options analyst and writer at Investors Observer. DISCLOSURE: Mr. Archer owns and/or controls diversified portfolios of long and short stock and option positions that may include holdings in companies he writes about. At publication time, Brent neither owns nor controls positions in AEO.
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