Thursday, Lowe’s Companies, Inc. (NYSE:LOW) stock fell 6% without warning. It wasn’t alone as Home Depot Inc (NYSE:HD) fell 4% along with a slew of other retailers. The reason for the mini crash was a headline that Sears Holdings Corp (NASDAQ:SHLD) will be selling a few appliances on Amazon.com, Inc. (NASDAQ:AMZN). SHLD spiked 10% on the news.
I think that the Wall Street reaction was a bit errant. For starters, buying SHLD stock on the news is wrong. This is a dying company whose latest idea is to give more sales to AMZN — one of the main reasons it’s dying in the first place.
Secondly, I understand that the markets price in future action of headlines, but in this instance, they extrapolated a bit too far. It’s likely that traders priced too much fear into quality names like LOW stock. While this may not be the absolute bottom in either, this is not the beginning of the end for them. This too shall pass, and therein lies the opportunity.
Click to Enlarge I want to sell downside risk into the overblown fears that currently exist in Lowe’s stock. Fundamentally, it trades at a 23 price-to-earnings ratio, which is in line with its main competitor.
I don’t compare it to the traditional brick-and-mortar store like Macy’s Inc (NYSE:M). They are not comparable. If I need a screw or a tool for an active project, I am not likely to order it on AMZN.
There will be risk. I do realize that there will be issues from AMZN chipping away at the top line sales of appliances. But for now the headline is limited to a specific maker and type. This opens the door for more products, so the risk is real but not imminent.
The question then becomes one of time. This potential cannibalization of sales is by my estimates still more than a year out. So for the mid-term, LOW stock will find a bottom and fight for its value. The “E” in LOW’s P/E is not likely to fall off a cliff and that should preserve the value against which I want to sell the risk.
So the thesis is simple: Sell risk against what others fear while the value persists. A chief ingredient in this implementation is that I am willing to own the shares at a 10% discount from this lower level.
AMZN Stock Trade Idea
The Bet: Sell the LOW stock Oct $65 put and collect $1.25 per contract to open. This opens risk that demands margin against to secure it. But if the price stays above my strike, then I keep the premium I collect for maximum gains. Otherwise, I have to own the shares and manage out of it to control the damage. I would lose money if the stock goes below $63.75 per share.
To mitigate the size of my risk I can sell a spread instead so I could avoid owning the shares. The downside is that the profits would be smaller in absolute terms but the yield remains juicy.
The Alternate Bet: Sell the LOW Oct $65/$60 credit put spread, where I have the same 80% theoretical chance of success but with much less risk. If successful, the spread delivers 15% yield. Compare this with trying to catch this falling knife by risking $73.50 here and without any room for error. At least by using Lowe’s options, I have a safety margin that lets me sleep better at night while LOW stock stabilizes a bit.
Investing is risky business, so I never bet more than I am willing to lose.
Learn options as easy as 1-2-3 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.