A consumer turnaround story that could take a while. How to play it with options

There’s a struggling auto parts stock where a notable activist is involved that could be ripe for a turnaround… but it may take some time. I’ll review how I’m playing it with options. Since hitting its all-time high in Jan. 2022, Advance Auto Parts (AAP) , which reports earnings this week, has grossly underperformed the stock market overall, even as its two most well-known competitors, Autozone and O’Reilly Automotive, outperformed significantly. O’Reilly has seen a total return of almost 78%, Autozone nearly 53%, and the S & P 500 more than 33%. Meanwhile, AAP has fallen more than 80%. Although Advance Auto was the smallest of the three at the end of 2021, these companies, ostensibly selling similar products, were within the same order of magnitude as of 2021. Advance did about $11 billion in revenues and operated about 5,000 retail locations with about 40,000 employees. Autozone, the largest of the three, did about $14.5 billion in revenues and operated about 7,000 retail locations with about 70,000 employees. O’Reilly had just under 5,800 stores. Revenues at both Autozone and O’Reilly have grown by high single-digit percentages per year since, with profit margins of around 14.5%. But the Advance topline has stagnated – actually declining on an inflation-adjusted basis, with net income margins of 1% or less, barely turning a profit. AAP 1Y mountain Advance Auto Parts, 1 year Between the company’s poor operating performance and the stock’s sharp declines, it is unsurprising that sell-side analysts aren’t enthusiastic. Advance Auto has only 3 buys. To put things in perspective, sell-side analysts generally rank the company in the bottom decile within the Russell 1000 and the consumer discretionary sector more precisely, compared to the 80th percentile for Autozone. A potential cause of this underperformance is corporate management. When similar businesses have vastly dissimilar operating results, it’s reasonable to question whether a shift in management and strategy can turn around an underperforming company. Advance Auto Parts seems a good candidate, and scanning the holders of AAP, it seems some well-known activists, such as Third Point agree . Investing alongside activist hedge funds like Third Point in “turnaround” stories can present a blend of potential rewards and risks. Activist hedge funds bring industry experience and often shake up company management or strategy. By investing alongside them, you benefit from their expertise in identifying changes that could boost company value. Activists target undervalued or underperforming companies to unlock shareholder value. If their strategies work, returns can be substantial, especially if they succeed in pushing the company toward operational improvement, asset sales, or strategic pivots. Activists often increase transparency within target companies and may go for cost reductions, streamlined operations, or a shift to more profitable product lines. If successful, these changes can significantly enhance long-term profitability and stock performance. In many cases, activists pursue either the sale of parts of the company or the entire company. This can lead to an acquisition premium on the stock, delivering quick, high returns to investors. Indeed, Advance Auto completed the sale of Worldpac to Carlyle Group this past week, which should net the company about $1.2 billion, providing needed capital to invest in improving the company’s supply chain – which has received criticism. Shane O’Kelly, who joined the company as CEO in 2023, was previously Senior VP/CEO: of HD Supply at Home Depot and would appear to be the ideal candidate to heal what ails the company. While the activist’s strategy may be sound, it might be challenging to implement due to market conditions or capital constraints. Companies targeted by activists often experience heightened stock volatility as market sentiment shifts in response to news about the activist’s involvement, board changes, or shifts in strategy. Activists can sometimes push for strategies that yield short-term gains at the expense of long-term growth, such as cutting R & D or selling profitable divisions, which may hurt the company’s future potential. However, the company has indicated that around $200mm of the Worldpac sale proceeds will be allocated to improving the company’s supply chain as soon as possible. The trade Right now, the options market suggests things could be very choppy at AAP for a while, particularly around this week’s quarterly earnings release. Options prices indicate a move of about 17% by the end of the week. Turnaround stories take time; this one will too. My suggestion? A strangle swap : Sell AAP Nov. 15 $30 put Buy AAP Feb. 21 $30 put Sell AAP Nov. 15 $45 call Buy AAP Feb 21. $45 call This will capitalize on the shift over time but capture elevated near-dated premiums to help finance it. DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. 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