Use Options to Snap Up Walmart on the Cheap

by Tyler Craig | February 20, 2013 8:34 am

Shares of Walmart (NYSE:WMT[1]) have taken a hit, falling 3% during the past two trading sessions after a leaked email said that the world’s largest retailer saw its worst sales start to a month in seven years[2]. But, hey, it’s not as if weakness in WMT is a new phenomenon. Since peaking at an all-time high of $77.60 late last year, WMT has exhibited notable relative weakness versus the broader market.

While the short-term outlook looks a bit precarious, the long-term view of WMT remains decisively bullish. As shown in the accompanying monthly chart, WMT broke out of a decade-long base when it finally vaulted above resistance at $65. Despite its recent bout of weakness, WMT sits well above this level. And, given the technical analysis principle of polarity, we can expect this prior resistance level at $65 to act as a potential support going forward.

WMTMonthly2 300x225 Use Options to Snap Up Walmart on the Cheap
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In the event WMT continues to decline in price, longer-term traders might look to the $65 zone as a low-risk area to snatch up shares.

Alongside the recent downturn, implied volatility has rocketed higher toward the upper end of its one-year range, reflecting an increased cost for front-month options. The increase in volatility also might be driven by an uptick in demand for WMT options as traders prepare themselves for the company’s upcoming earnings release Thursday.

WMTvol 300x196 Use Options to Snap Up Walmart on the Cheap
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In light of the elevated implied volatility, one option strategy worth consideration — particularly if you’re looking to buy shares of WMT in the $65 area — is the naked put.

By selling a put option, traders obligate themselves to buy shares of stock at the strike price if the option sits in-the-money at expiration. If the option sits out-of-the-money at expiration it will expire worthless, allowing you to keep the premium received when you initially sold the put.

With WMT currently trading at $68.76, you could sell the March 67.50 put for $1.02. The max reward is limited to the initial $1.02 received and will be captured if WMT remains above $67.50 by March expiration. If WMT falls beneath $67.50 and you ride to expiration, you will be required to buy 100 shares at $67.50. However, when we take into account the initial $1.02 received, your true cost basis falls to $66.48.

Traders looking for a more conservative approach could sell the April 65 put for 70 cents instead. Although the potential profit is less, the trade only requires WMT to remain above $65 and will rack up losses slower than the short put in March.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. WMT: http://markets.financialcontent.com/investplace./quote?Symbol=WMt
  2. worst sales start to a month in seven years: http://slant.investorplace.com/2013/02/is-the-big-walmart-warning-a-bearish-sign/

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