The retail sector is not usually a momentum trading vehicle. Headlines from Amazon.com, Inc. (NASDAQ:AMZN), however, have transformed it into one. Recently, we saw a crash that persisted for a few days before partially whipsawing to recovery, regaining about half its lost value.
The SPDR S&P Retail (ETF) (NYSEARCA:XRT) is down about 20% since its December 2016 high, but it has recently set an interim bottom in price-pattern terms. It has bounced off $38.80 on two tests. These can eventually turn out to be a temporary double bottom from where the retail sector can repair some of the technical damage it incurred. That said, I’m not saying that I’m mega bullish on the sector.
Wal-Mart Stores Inc (NYSE:WMT), being the retail behemoth that it is, did not sit out the recent excitement. WMT stock recovered almost half of the 8% correction it recently suffered. But technically, it sits just below the open gap chasm from June 16. While markets usually like to fill open gaps, this one could have some resistance built into it.
Back in May, WMT stock spiked to the $79 area too quickly. This made for weak hands who, on the first sign of trouble, bailed on their profits. So it will take another specific reason for them to jump back in as fast.
Click to Enlarge While I sound bearish Walmart, my thesis for trading WMT stock today is bullish. But not in the sense that I expect a big rally from here. I like to sell risk below value for income, and with WMT at an 18 price-earnings ratio is what I consider value.
This is about one-third less than that of Costco Wholesale Corporation (NASDAQ:COST), which is also a value stock in my book.
So instead of chasing a price higher, I’d much rather own the value. Meaning I’d risk owning WMT shares at a discount, especially if someone pays me for this opportunity. In essence, I generate income by selling downside risk against what other traders fear.
How this works is that I sell puts below a level where I want to own WMT stock. If price falls below it then I own the shares. Otherwise I keep the premium as income.
It would take a serious change in fundamentals for WMT to become a giant mistake at a 9% discount from today. So this is the definition of a calculated risk that I am willing to bear. I am confident that I can manage my exposure against the short-term price action with this size buffer.
The Trade: Sell WMT Oct $67.50 put and collect 55 cents to open. Here I have a 90% theoretical chance of keeping my whole premium for maximum gains. If price falls below my strike, however, then I must own the shares and accrue losses below $67 per share.
If I want to mitigate my exposure and not risk owning the shares then I would use a bull put spread instead of selling naked puts.
The Alternate: Sell WMT $70/$67.50 credit put spread where the odds of success are about the same, but the risk is much more limited. Yet the spread still can deliver an impressive 12% in yield. Compare this with risking $76 per share now and, with absolutely no room for error, hope for a double-digit rally to match the performance of the spread.
I am not required to hold my trades open through expiration. I can close any of them for partial gains or losses at any time.
Just remember, investing comes with many risk, so never take trades that could break your portfolio.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
