This morning Kroger (NYSE:KR) is falling 8% on its earnings report. Management hit most of its metrics except there were concerns over its top line and margin. Guidance was also disappointing. It is my opinion that this is an overreaction that is likely to be an opportunity to trade it again.
Fundamentals matter, but one report from a successful company doesn’t usually change the bullish thesis. Kroger stock is a proven winner, so it deserves the benefit of the doubt, especially when the concerns were not a total surprise.
Traders this morning are overly focused on one set of numbers; in this case, same-store sales. The margin pressure issues weren’t a sudden development. Management had warned about headwinds there going into this past quarter because of investments into future benefits.
This short-term pain for longer-term gain. But therein lies the opportunity. Today I want to profit from others’ fears. Kroger is successfully fighting the Amazon (NASDAQ:AMZN) competition. Investors should know that this is a long game, not one to end in one quarter.
Last year, KR stock fell off a cliff from a headline from AMZN. Back then, the experts sounded the death tolls for the grocery store chains and not just this one. Then slowly but surely, investors came to grips with the idea that they can all coexist and the stock recovered to set a higher high.
Part of this recovery must have come from the realization that KR will adjust to fighting Amazon. That would entail management need to invest in strategically thinner margins and this is what they just did. So a slight miss here is manifesting itself in an overreaction on Wall Street once again.
Furthermore, this morning’s dip brings it back into a weekly support pivot zone. Those tend to act as support on the way down.
No, I am not reckless, so I don’t expect an immediate spring back. Consequently, I won’t buy the Kroger shares outright and risk my money right away hoping for a rally to profit. Instead, I use options where I can set a trade that doesn’t even need a rally to profit. If one comes I would be profitable faster but even if the stock falls 15% from this dip I could still retain my maximum potential gains.
Fundamentally, KR is cheap trading at only 10 price-earnings (P/E) ratio. So I am confident that owning shares at a discount from here will not be a financial debacle and that is key to my trade setup. If shares fall below my support level then I have to own the shares at that price.
Technically, Kroger stock came into the earnings event up 14% for 2018. So, even after this dip, it would still be positive for the year. This dip doesn’t do tremendous technical damage. The weekly chart is still constructive so without new fundamental headlines scaring investors this too shall pass.
Most analysts are on hold for the KR stock and it’s trading above their average range for it. So we could see a few headlines there that could move price.
The Trade: Sell KR Jan $24 put and collect 48 cents per contract to open. I have a 85% theoretical certainty, so that I retain maximum gains. Otherwise, I will accumulate losses below $23.52.
Selling naked puts is daunting. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell the KR Jan $24/$22.50 bull put spread, which has about the same odds of winning and would yield 18% on risk. Compare this with risking 29 per share here and without any room for error and expecting a rally to profit.
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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.
