This week Kroger Co (NYSE:KR) spiked 5% on a headline that it was selling assets. The assumption is that it would use the proceeds to lighten its debt load. This headline is not worth chasing higher, but I can still profit from it.
I don’t like to chase baseless rallies. The knee-jerk reaction on Wall Street mistakenly assumes that the asset sale will change the current operating parameters for the company. Kroger will still continue to have the same current operating disadvantages.
In general, supermarket chain margins are getting thinner — not to mention the additional squeeze that the recent entrant known as Amazon.com, Inc (NASDAQ:AMZN) will have on the sector. Traders who were worried about KR profitability before the headline should still be worried thereafter.
AMZN, with the Whole Foods Market footprint, brings the fight to the local level.
Although I don’t like the huge spontaneous upside reaction in Kroger stock, I am not shorting it today. I do see tangible value in the stock and I can monetize it. It sells at 12 price-to-earnings ratio which is low in absolute and relative sector terms. It also pays a dividend.
Technically, Kroger stock is at a level of contention which has been in place since October 2013. While I don’t know its outcome this time, I do know that I am willing to place risk on a bullish trade. No, I will not buy the stock outright and expect a rally like most chasers. Instead I will use options where I know I can create a sizable buffer zone.
If KR management is successful at shoring up their balance sheet, it would make the value argument even stronger. So I don’t mind owning shares at a discount from current price should my thesis be broken.
Official expectations are muted on Wall Street for KR stock. Most analysts have a hold rating on it. They are not yet willing to stick their necks out. Luckily I don’t listen to them as they tend to be late to the party. This leaves room for upside surprises, especially if this rally continues for a few more days.
Click to Enlarge Furthermore, KR stock is now trading just below the average price target. But there is much more room above than below inside the Wall Street range.
This week’s rumor is good news for the stock but not every bullish trade will profit. Mine will regardless!
KR Stock Trade Idea
The Trade: Sell the KR Apr 2018 $16 put and collect 50 cents. This is a bullish trade where I have an 85% theoretical chance that the price will stay above my strike. Otherwise, I own the shares at $16 and would suffer losses below $15.50 per share.
Selling naked puts carries big risk. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the KR Apr 2018 $16/$14 credit put spread where I have about the same odds of winning. If so, the spread will yield 12% on risk.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
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 as @racernic on twitter and stocktwits.
