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.

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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.

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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.

  1. WMT:
  2. worst sales start to a month in seven years:

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