Like a sprinter in need of a breather after a 200-yard dash, stock prices often require some type of break following an uninterrupted rally. As prices reach overbought status, buying pressure abates while sellers become more aggressive. This shift in the supply-demand equation usually tips the scales back to some type of equilibrium, resulting in sideways price movement for a spell.
Of course, if the shift is dramatic enough, prices will fall as the baton is passed from bulls to bears.
We’ve seen a correction of the former variety in the Retail SPDR (XRT) over the past month. Since its rapid 12-day ascent off the June lows, XRT has consolidated in a tight, narrow range between $80.25 and $81.50. Thus far, the base has been virtually textbook — a prime example of how prices behave when neither buyers nor sellers possesses the upper hand. Obviously, the stalemate will end at some point — one party eventually will overwhelm the other, bringing resolution to the tug o’ war and a strong directional move.
In light of the overall uptrend XRT finds itself in, the current consolidation pattern is more likely to break out to the upside.
Click to Enlarge Further bolstering the bullish case in XRT is its interminable relative strength. It has outperformed the S&P 500 Index with nary a hiccup for the entire year as shown by the relentless rise in the comparative relative strength study in the accompanying chart.
What’s more, XRT has bested the performance of every other major market sector — financials, healthcare, industrials, et al. — for the past quarter as well as year-to-date. Whether retail’s rise continues into the wild blue yonder remains to be seen, but a breakout of the recent base would certainly provide a low-risk entry point.
With the recent ebb in implied volatility, buying call options might not be a bad way to go for those looking for a more aggressive bet on retail in the coming months.
You could buy the Dec 81 call for around $3.70 once a breakout is confirmed. Buying out to December provides a bit of extra time should XRT experience a minor correction between now and then. Plus, it will allow the opportunity to participate in any holiday boost retail stocks might receive heading into the holidays.
The max risk is limited to the debit paid for the call option while the max reward is unlimited.
On a side note, today’s Fed meeting and Friday’s employment report remain large X-factors promising to trump even the best of setups, so be aware that these market-moving events could sully our otherwise clean setup in the land of retail.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.