While TJX Companies (NYSE: TJX) has been a choppy name this year, circumstances took a decidedly negative turn recently. Following the disclosure of the off-price retailer’s second-quarter earnings report, TJX stock found itself staring at a sea of red ink. In the trailing five sessions ending Aug. 20, the ticker suffered a decline of almost 7%.
At first, the downfall seemed a bit harsh given that the discount specialist demonstrated strong growth in its home goods business. Unfortunately, that wasn’t enough to overcome a slowdown at its TJ Maxx and Marshalls discount apparel chains. In addition, broader concerns exist about the viability of domestic consumer spending.
There was also an acknowledgement that the company itself could have operated more efficiently. In a post-earnings call, CEO Ernie Herrman admitted that TJX “could have executed our store mix better” at TJ Maxx and Marshalls. In particular, the head exec noted that certain products that typically would spark impulse buying were missing from store shelves.
Still, Herrman believes that the “…issues were self-inflicted and within our control.” If so, it’s possible that a bullish case exists for TJX stock.
Mainly, the narrative comes down to mean reversion. When solid, relevant companies succumb to temporary pressure, it could trigger buy-the-dip sentiments among professional and institutional players. Of course, this hypothesis would come under greater skepticism if we were dealing with a luxury discretionary name.
However, as an off-price specialist, TJX Companies should benefit from the trade-down effect, where consumers naturally shift their spending habits toward cheaper alternatives. TJX is one of those brands that operate on the lower rungs of this ladder, making a contrarian trade more plausible.
Even better, there appears to be significant pessimism right now due to the poor performance of TJX stock. As such, the volatility skew reveals hedging behavior indicative of uncertainty. Undoubtedly, it’s risky to go contrarian after a disappointing financial disclosure. But I believe there might be an interesting argument here.
Understanding the Presupposition Baked into TJX Stock
Every forward-looking analysis of a publicly traded security faces a core problem: no one knows what the future may bring. In fact, from an epistemological viewpoint, it is impossible to rely on any one forward event with absolute certainty. Even the concept of the sequential nature of time — that there are concepts of “before” and “after” — are presuppositional.
Now, just because an argument utilizes presuppositions doesn’t necessarily make it invalid. When you’re talking about the unknown future, a presuppositional framework is inevitable. But when it comes to something like TJX stock, the key difference among models is typically understanding which premises are more reasonable than others.
For example, I’m looking at the 140/145 bull call spread expiring Sep. 18. Traders are hoping that TJX Companies stock will rise through the $145 strike price at expiration. If it does, the net debit paid of $235 will become a maximum profit of $265 or a max payout of almost 113%.
Now, at time of writing, TJX stock trades hands at $140.69. For the security to trigger the $145 strike at expiration, it would need to move up 3.06%. At a quick glance, this goal represents a challenge because the implied volatility (IV) of the Sep. 18 options chain sits at around 21%, whereas the historical volatility for this time period runs a bit higher at over 23%.
Accordingly, Wall Street assigns modest odds that TJX Companies stock will be profitable. At the moment, the chances that TJX will trigger the breakeven price of $142.35 are set at 42.2%. If we look at the probability distribution screener, the odds that the ticker will hit the second-leg strike at expiration are 34.70%.
If we ran an expected move (EV) calculation on this transaction, it would be hard to view the call spread as anything more than a steadily sinking ship. Over the theoretical long run, taking this exact wager would lead to far more losses than gains.
The problem here is the underlying assumptions that go into the above probabilities. Wall Street is pricing this option spread as if TJX stock will undergo a random walk between now and the expiration date. Imagine the ticker traversing through these next four weeks, with each session in this period being adjudicated by random chance.
Over this cumulative period, the chances that TJX stock will hit $145 on Sep. 18 are defined at just under 35%. But that’s only true if we grant the presupposition of a random walk.
There’s Another Presupposition: The Nonrandom Walk
My view is very simple. Rather than assume that TJX Companies stock will undergo a random walk from now to expiration, I believe that the ticker will undergo a nonrandom walk. How can I be so sure? Well, to be honest, I don’t have the greatest of confidence. Nevertheless, we know from past data that whenever TJX suffered an extended downturn, the result has been an above-average performance — at least for certain weeks.
Specifically, in the last 10 weeks, TJX stock printed only three positive weekly candlesticks, thus leading to an overall downward slope across the period. Under this 3-7-D quantitative sequence, the nature of the response over the next 10 weeks changes relative to the random baseline.
Most conspicuously, after four weeks following the flashing of the above signal, the median endpoint expectation for TJX stock is to hit the equivalent of the $145 strike price (using data since January 2019). In other words, out of the 20 times that the signal has flashed, past patterns suggest that half of the outcomes should land above $145, while the other half should land below $145.
Yes, the sample size is very small — that’s why it’s not statistically possible to have high confidence in the trade. However, if we were to go with an inductive framework, the Sep. 18 140/145 bull spread would seem to make sense.
Caveats to Keep in Mind
Does this mean you should abandon all caution and buy TJX stock right now? Not without keeping the risks in mind. Any inductive analysis always risks falling prey to the black swan. Basically, you can infer where TJX may end up at a certain point in time but you cannot guarantee that the observed pattern will repeat in the future.
Also, you must consider that options trades are cruel because of the specificity involved. My last story about TJX stock — published on June 30 — is a great example. I was bullish on TJX and the charts have ultimately justified this general direction.
Sadly, I was too bullish and that’s why the trade ultimately failed at the end. This trade right now is far more conservative — but that doesn’t necessarily mean it will be successful. As always, you must enter the derivatives market with both eyes wide open.
