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Morning Update

Yesterday’ trading session was extremely whippy as comments and rumors out of Capital Hill pushed markets first deep into the red and then back to unchanged on the day on extremely light volumes. Some of the most interesting price action was in the VIX. The index traded to nearly 21 when stocks were at their low, and the futures went into slight backwardation. Backwardation is when the near month future is more expensive than the back month and signals extreme market anxiety. However as soon as news broke that the House would reconvene Sunday night in Washington stocks took off and the VIX sold off to close on the lows of the day. In these low volume markets it does not take much to get major market moves and reversals like we saw yesterday. Today Obama is scheduled to meet with Congressional leaders and I expect the market to hang on their every word.

Yesterday’s retails sales data was weaker than expected, which prompted a selloff in retail stocks. However one option trader was buying calls on the weakness in Michael Kors. The trade was the purchase of 870 Jan. 55 calls for $0.55 with the stock at 48.80. This trade will profit if KORS is above 55.55, 13.8% higher, at January expiration.

Michael Kors has been a public company for just over one year and is up over 80% in that time. Despite the run up in its shares the company was added to Goldman’s conviction buy list last week and remains a strong buy at Citi. The reason is expectations of strong growth in Q1 and Q2 of 2013. Growth is expected to be driven by very selective discounting, increasing jewelry sales, and increasing brand awareness in North America. However, the stock faces some risks, such as slowing department store traffic and potentially higher taxes on target market due to the fiscal cliff. But KORS is well positioned to weather these risks. By having minimal exposure to Asian and European markets the company is not subject to the slowing economies overseas. Also, by offering upscale products that are more affordable than the highest end designers like Prada and Louise Vuitton its products are seen as an affordable luxury among consumers. Within North America KORS has plenty of room to grow and the brand continues to gain consumer awareness due to the appearance of Michael Kors himself on Project Runway.

Further growth in this stock will be driven by continued earnings growth. The stock is trading at 40 times trailing earnings, which shows traders are betting heavily that these sales will continue their dramatic increase. KORS is positioned to do better than many US retailers in Q1 of 2013 but growth rates could slow if the US goes off the fiscal cliff or economic growth stagnates. Because of the stock’s high PE ratio I would only play this stock with out of the money calls in order to keep downside risk as limited as possible. KORS bounced off of its 200-day moving average yesterday and I think buying into the weakness with the stock at this support level makes sense.

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