Overstock (OSTK) is an online retailer that manufactures and brick & mortar retailer use to unload unwanted or “overstocked” product. To fulfill this mission, the company operates through two segments, Direct and Partner. In the Direct segment, the company acquires inventory and then sells it to retail buyers. In the Partner segment, the product is owned and shipped by the producer or retailer. Product categories including furniture, home decor, bedding and bath, housewares, jewelry and watches, apparel and designer accessories, health and beauty products, electronics and computers, and sporting goods. It also sells books, magazines, CDs, DVDs, and video games. Smaller lines of business include online retailing of food and insurance products.
The company operates in a very competitive space, to say the least. Amazon is the big gorilla in the general retailing in the online space. They compete head-to-head with Wayfair who focuses on home furnishings. Overstock has always had a challenge attaining consistently profitability. Nonetheless, they still find a way to stay in business and grow. Wayfair has never been profitable and they have been disrupting OSTK’s business lately as they spend heavily on advertising as they struggle to achieve economies of scale and attain profitability.
Since OSTK is not consistently profitable, and when it does earn a profit, it is challenged to meet the cost of capital. As a result, the company does not sit on our radar screen on a daily basis. But we noticed that the share price of OSTK took off and this got us intrigued and we want to know more.
The chart above shows that the sharp rally has turned into a buying panic. The RSI is telling us that the stock is massively overbought. There is a huge volume spike indicating that “panic” buying has been going on. But if there are panic buyers, who are the opportunistic sellers? There is an old saying in the market that goes something like this. When they demand the bag, give it to them.” The question is why? Why has the market cap of this company risen from about $300 million to $740 million currently in just 4 months?
It seems that OSTK is getting into the cryptocurrency game. The company announced at the end of September that tZero, a subsidiary of Overstock.com Inc., has formed a partnership with the Argon Group and RenGen LLC to form a digital tokens exchange. The company says they will be the first exchange to be in compliance with Securities Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) guidelines. If you were a close follower of the company, maybe you could have predicted this, as the company has accepted Bitcoin as a payment method since 2014. But that is speculative at best. If you would like to read more about OSTK’s plans, read here.
We are just as interested in what the price action says about the company as what it does not say. Buyers of this stock think the exchange business, which has not started up yet, is worth 2 times the retail business. It is also a sign of the cryptocurrency craze that is going on right now. The company has lost money the last 12 months, $0.52/share to be precise. Fortunately, the company has cash that exceeds debt on its balance sheet, so the company has staying power. All-in-all, we would be a seller on the emotional enthusiasm which is aligning with an overbought condition on the technical side and excess valuation of the fundamental side. Aside from losing money, the company trades at about 4.4 times book value, so the market gives them a fair bit of “blue sky.”
If you are a very aggressive and risk tolerant investor, you might want to take a bearish position on the stock. The only way we would do this is with options and one must limit their risk. The options are priced with an implied volatility of 95%. So a December 15, $30 strike put costs $5.10. One would need the stock to fall to $24.90 just to break even. Instead, we will have to take the more traditional approach for us and sell an out of the money call spread. With the stock trading at $29.00, we suggest the following structure.
To initiate this trade, the investor will collect $165 up front, which they will get to keep so long as the share price trades below $30.00 at expiration. The breakeven level is $31.65, which is about 9.0% above the current price and the efficient market hypothesis suggests there is a 67% chance of success on this trade. The most one can lose is $335 per call spread. This would occur if the share price traded above $35.00 at expiration, which is about 20.0% above the current price. Given the high volatility of this stock at the moment, this is a possibility. With an expectation that the share price has hit peak emotion, we expect the spread to ultimately expire worthless as the share price falls to consolidates, allowing investors to keep the premium collected up front.
You might think that we have missed the boat and the cryptocurrency is a new way forward and that all things crypto are not in a bubble. If this is your belief and you think the price of OSTK will be heading higher than you should consider 3 choices. (1) Buy stock, (2) sell a cash covered put. You would make up to $5.10 if the share price holds up. If you are more conservative, sell a December 15, $25 strike put for 2.10 or use the $20 strike and collect $1.00. (3) Decide that there is too much emotion and risk here and stay on the sidelines, observe and use this as a learning exercise.