You’ve no doubt heard talk of the “new frugal,” a shifting in the consumer mindset toward more judicious managing of personal finances, i.e., a tightening of the purse strings. And this mindset is not something that’s likely to disappear anytime soon, especially with the threat of a double-dip recession looming.

Obviously, this means less money spent on items that fall in the “I want it” category versus the “I need it” category. And the ones that will see the biggest hit are those that fall in the “I want it and never, ever will I really need it.” The sales of these products — from Harley Davidsons to expensive lingerie — are falling off a cliff.

So let’s talk about how traders can play this trend with ETF options.

Finding the Right Retail ETF

There are a lot of exchange-traded funds (ETFs) covering this segment, so it’s important to pick the right one. If you take a look the retail ETFs’ holding, you will see that most are not exposed to high-end retailer, which are the ones that will suffer most in a stagnant or declining economy. Instead, many of these ETFs have giant chunks of stores like Wal-Mart Stores, Inc. (NYSE: WMT), Costco Wholesale Corporation (NASDAQ: COST) or Dollar General Corp. (NYSE: DG). Others are loaded with consumer staples such as The Coca-Cola Company (NYSE: KO).

What you need to look for is an ETF that:

1. Is not exposed to stable companies providing “I need it” products or brand-name consumer favorites; and

2. Is highly diversified and will not run away from you if one or two of the companies does better than expected.

The retail ETF that best fits these two criteria is the SPDR S&P Retail ETF (NYSE: XRT). This ETF tracks the S&P Select Retail Industry Index, and holds roughly 100 stocks with none accounting for more than 1.7%, and the top 10 holdings equaling less than 17%. The top 10 include everything from Sally Beauty Holdings, Inc. (NYSE: SBH) to CarMax, Inc. (NYSE: KMX). This means two things for traders: reduced volatility thanks to its diversity and more exposure to the retail segment that should suffer most.

2 Ways to Short XRT

A poor back-to-school shopping season is behind us, but we are approaching what will turn out to be a very disappointing holiday season. So you have two choices here:

1. October XRT Puts

The short-term play is to buy puts on XRT that expire in October. This will reflect full data on same-store sales from the back-to-school season and preliminary Q3 GDP data, which should be a big disappointment.

The October position offers the potential for a better return with a higher risk profile. It leaves you exposed to a possible rally if the S&P temporarily breaks through the current trading range.

2. January XRT Puts

The January puts are the lower risk play. You’re giving yourself more time for this trend to play out, and disappointing holiday sales could give these options a boost.

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