How to Generate Income Off Five Below’s (FIVE) Unusual Options Activity

Discount retailers like Five Below (FIVE) haven’t been thriving recently, even though current economic conditions might seem ideal for them. In late August, the U.S. Labor Department revealed that the country added 818,000 fewer jobs than originally reported between April 2023 and March 2024. This sizable shortfall suggests a weakening consumer economy, a scenario that typically benefits discount retailers like FIVE.

However, FIVE stock has not reacted favorably to these developments. Since the start of 2024, FIVE has lost a staggering 65% of its equity value. In July, the company announced that then-CEO Joel Anderson had stepped down, with Chief Operating Officer Kenneth Bull stepping in as interim CEO.

To make matters worse, Five Below projected a comparable sales decline of 6% to 7% for the second quarter. This warning mirrored the bleak outlook given by competitor Dollar General (DG) during its Q2 earnings report. With consumers in the discount sector tightening their budgets, the environment does not appear favorable for FIVE stock.

Adding to the challenges, a class-action securities fraud lawsuit has been filed against Five Below. According to the lawsuit, the company allegedly “misrepresented its accelerating store traffic, merchandising opportunities, and store expansions that underpinned its long-term growth.”

Despite these headwinds, much of the bad news may already be factored into the stock price. While the outlook for FIVE and its peers remains grim, the market may have already absorbed the worst of the negative news. As a result, it’s possible that FIVE could move sideways or even experience slight gains.

This is where a bull put spread might be a smart strategy.

Options Activity Hints at Potential for FIVE Stock

On the last day of August, FIVE stock fell by 3.59% in the open market. This decline also attracted attention from options traders. At first glance, the smart money seemed to be betting on further declines. However, a closer look reveals a more nuanced picture.

On that Friday, total options volume reached 24,567 contracts, with an open interest of 79,510 contracts. This represented a 323.35% surge over the trailing one-month average. Put volume reached 14,585 contracts, while call volume stood at 9,982 contracts. This put/call volume ratio of 1.46 suggests a bearish sentiment at first glance.

Puts give holders the right, but not the obligation, to sell a security at a specific strike price. Normally, this signals bearish intent. However, selling puts involves taking on the risk that the security will not fall below the strike price. This suggests a more neutral or even bullish outlook.

Further supporting this interpretation, Barchart’s options flow screener, which filters for large block trades likely executed by institutions or professional investors, showed a net trade sentiment of $473,300 in favor of the bulls. The most bullish transactions were sold puts across various strike prices and expiration dates.

Therefore, while the elevated put/call ratio might initially appear bearish, the reality is that major players are selling puts, indicating they believe the worst may be over for FIVE stock. This strategy implies that, at the very least, FIVE will likely trade sideways until the options expire.

If the top institutional traders are making this bet, it might not be wise to go against them.

The Mechanics of a Bull Put Spread

For investors considering a bull put spread, there are several strategies available depending on risk tolerance. One option, using derivatives expiring on Sept. 20, 2024, could look like this:

• Sell the $70 put at a bid of $1.30.
• Buy the $65 put at an ask of 55 cents.

Here are the key stats for this trade:

• Maximum profit: $75 (net premium of 75 cents multiplied by 100 shares).
• Maximum loss: $425 (difference in strike prices minus net premium received, multiplied by 100 shares).
• Breakeven price: $69.25.
• Risk-reward ratio: 5.67 (for every $1 in income, the trader risks $5.67).

The advantage of this strategy is that you can win in one of two ways: if FIVE stock rises by September 20, or if it simply trades sideways. Additionally, you have an 8.2% cushion between Friday’s closing price and the breakeven point.

Of course, the risk remains that FIVE may continue to decline. The stock lost nearly 9% of its value last week alone. Still, after such a sharp drop, the bulls may step in to stabilize the stock.

If that happens, a directional bet on FIVE may not yield great returns. However, if the stock remains flat, a bull put spread allows you to generate income while keeping your downside risk under control.