Game the Retail Stock Recovery with the SPDR S&P Retail (ETF)

Retail stocks, long since left for dead, are suddenly in vogue. November was a banner month for the space with the  SPDR S&P Retail (ETF) (NYSEARCA:XRT) climbing 11%. What’s perhaps more impressive is that XRT breached a key trendline and its 200-day moving average. With this industry now in the spotlight, expect trade opportunities to multiply.

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When testing the strength of a breakout, chartists use three filters — price, time and volume. Let’s apply each to the recent XRT breakout over the 200-day moving average ($41).

First, the price ramped all the way up to $45 after the resistance breach. That type of follow-through confirms the breakout was the real deal.

Second, since hurdling above the 200-day on Nov. 17, we’ve now spent three weeks above it. False breakouts usually fail within the first few days of the resistance breach.

Third, trading volumes in XRT have exploded revealing that significant institutional buying is supporting the rally. Throw it all together, and the new uptrend in retail is here to stay. You should view dips as buying opportunities for the foreseeable future.

In the short run, the retail ETF is overbought, which favors a price pause, if not a pullback. Couple that with its current implied volatility rank of 53% and I think we can make a case for selling strangles here.

This unique options strategy will obligate us to buy XRT down around $41 (which would be great given our outlook) or get short up around $47. The logic for the second outcome is that if XRT were to rise toward $47 it would be extremely stretched and thus worthy of acquiring bearish exposure.

The Strangle Trade

Sell the Jan $46 call and the Jan $42 put for a net credit around $1.11. If XRT trades sideways for a few weeks and implied volatility comes back down, then you should be able to buy back the strangle for around 55 cents. That’s your target.

The risk is that XRT rips too far above $47 or craters below $41. You could simply exit on a break of either level or ride to expiration and allow assignment. If the short put sits in-the-money at expiration, you’ll be obligated to buy shares at a cost basis of $40.89. If the short call lies in-the-money, you will have to sell the stock short at a cost basis of $47.11.

As of this writing, Tyler Craig held bullish option positions in XRT. Want more education on how to trade? Check out his trading blog, Tales of a Technician.

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