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Buy Puts on Scotts

It’s finally time to get back out in the yard, tend to our gardens and prune those bushes that haven’t been touched all winter. Spring is here, and we can emerge from our winter hibernation at long, long last.

And now that much of the country is seeing winter finally fade away, it’s time for a new trade: Scotts Miracle-Gro Company (NYSE: SMG), a leading gardening and landscaping company. However, today’s trade is probably not what many would expect — we’re going to buy puts, a bearish position.

That’s because Scotts regularly follows a seasonal pattern that sees its shares weaken from early April through late summer.

So, we are going to capitalize on this trend today by adding a new option…

Action to take: Buy to open the SMG September 18, 2015, $65 put option (SMG150918P00065000) for less than $4.25. At last glance, it was trading at $3.60.

Scotts’ downturn is counterintuitive but logical. Investors buy stock during winter and early spring in anticipation of Scotts’ strongest earnings season (the first quarter), and when it finally arrives, the early buyers grab at the chance to take their profits. The shares then weaken over the summer months before the late-year rally heats up again.

You can see it in the chart:

Scotts’ History of Sell-offs

See larger image

The lone exception in the last four years is 2013 (shaded orange), where the stock continued to rally through its seasonally weak period. This was because of 2013’s dramatically late spring. Investors didn’t really know how to handle this deviation from the seasonal norm. So when Scotts announced on its May 2013 conference call that the late spring had pushed the majority of its sales into the next quarter and that it was set to beat expectations, investors stuck around.

But I’m not expecting that this year because, as Chris Orr mentioned in the spring report, this spring is an early one.

I asked Chris for some more updates on this year’s spring, and here’s what he had to say: “The Northeast U.S, Ohio and Michigan will be off to a slow start, but the rest of the U.S. will have an earlier spring than the previous two years. I spoke with my sister in California near the San Bernardino area just the other day and she said everyone is planting gardens at least three weeks early because of the nice weather.”

It looks like this year is shaping up like every weak seasonal pattern that Scotts has experienced before. The run-up in the stock is going to peter off and reverse soon as investors start to bail, and we’ll be set to profit. While I plan to hold this position until about August, I will continue to follow it and alert you if we should lock in profits early.

I also wanted to give you a quick note on our Carnival (NYSE: CCL) position. The company reported earnings late last week, topping estimates and sending shares higher by about 6%. We have a bearish position on this company, so the earnings beat was a temporary setback — but we purposefully went into the longer-term October puts so that we have time for Carnival’s downtrend to play out.

Remember, we are playing Carnival’s seasonally weak quarter, which is announced in July, so I expect shares to drift lower as we approach the summer season.

The Mainstream Catches Up to Us

Before I sign off, I asked Chris to touch on an interesting article I saw the other day that underpins our main reason for creating the Precision Profits service — that companies use weather all the time to explain their operations.

Here is Chris:

IBM announced a strategic alliance with The Weather Channel and Weather Services Inc. (WSI) to start helping corporations predict how their businesses will be impacted by the weather.

WSI, a subsidiary of The Weather Channel, has provided weather information to businesses for decades. This team up will utilize IBM’s large business database and WSI’s database of historical and current weather. The idea is to integrate weather technology with IBM’s platforms, like Watson Analytics, to give businesses the information they need to make better weather decisions.

Weather, of course, impacts business. Just a quick read of any first-quarter reports from the last three years will tell you that. In fact, Precision Profits is designed around the premise that businesses are impacted by the weather, whether they say so or not.

The concept of considering the weather when making decisions about product lines, supply chains and marketing is not new. Sears, Roebuck and Co. had staff meteorologists starting after World War II to do just that. Sears took advantage of the weather forecast to move inventory between stores and to do things as simple as placing umbrellas at the front of the store before it rained.

More recently, Subway stores correlated sandwich sales with the weather. They now know that people buy more Spicy Italian subs during certain weather conditions, for example.

IBM and WSI plan to make a robust database for a wide variety of businesses that addresses, they say, individual business pain points. They also want to help companies control consumer actions through apps. IBM says an insurance company will be able to send you a text message alerting you to a hail storm and giving you solutions, such as telling you about a safe place to take your car.

IBM says integration of business data with weather information will be rolled out over the next four years as they ramp-up their cloud services.

The success of the venture hinges on the accuracy of the weather forecasts. The computer models WSI uses stretch out 15 days and they do some 30-day and seasonal forecasts, too. 

Precision Profits, as you know, tracks longer business trends by using forecasts stretching out three to six months or longer, so weather’s role in business isn’t news to us. But it looks like the mainstream is finally waking up and taking more notice. A big reason is probably because of another poor first quarter due to extreme winter weather. Economists are estimating that the economy grew slightly more than 1% in the first quarter, which is half the modest average of about 2.2% it saw throughout the nearly 6-year-old recovery. And everyone’s blaming weather — which is exactly what Chris told us to prepare for.

Until next time, good trading…

Jeff Opdyke
Editor, Precision Profits