Increased volatility in the retail sector as earnings season continues
03/02/17

The retail sector is seeing increased levels of volatility as key players report various earnings in a fiercely competitive environment.

This week Target (TGT) and Lowe’s (LOW) both announced their earnings. Traders were quick to react to each of the announcements:

  • On Tuesday Retail Consumer Discretionary store Target (TGT) traded down 12% to $58.75 after announcing lower than expected sales numbers which exposed a disappointing 2017 earnings outlook. To protect against further downside losses, more than 27,000 of the 17-Mar 60 puts (options to sell a security) were bought. These puts can also expire worthless if the stock does not move below the strike price.

  • On Wednesday before the open Home Improvement Retailer Lowe’s Companies (LOW) announced earnings that outperformed on both revenue and earnings, amid solid same-store sales growth. Traders came in buying, taking LOW stock up more than 9.5% where it traded as high as $82.85 intraday. Traders looking to use options to speculate that LOW stock will continue higher have purchased more than 1,200 17-Mar 81.5 calls (options to buy a security) where previous open interest had only been 300. These calls can also expire worthless if LOW does not move above $81.50.

On Thursday we have two more retailers announcing earnings: before the open Retail Food & Drug Store Kroger (KR) will announce Q1 2017 earnings, and after the close Retail Consumer Cyclical Store Costco (COST) will announce their Q1 2017 earnings. The options markets can give an indication of the potential risk/reward relationship going into the earnings announcements. By looking at both calls and puts (an options strategy known as a straddle) of the nearest term options, traders can get an approximation of the potential price risk of the stock.

In Kroger (KR) for example, the stock has been trading around $32 for about the last week, while the 17-Mar 32 calls are trading for $1.20 and the 17-Mar 32 puts are trading for $0.90. By adding the call and put prices together, the market is pricing in a potential move in KR stock price of $2.10 away from the 32 strike price.  This means the markets are pricing in a potential 6.5% move either up or down in KR stock before March expiration ($2.10/$32=.065).

With Costco (COST), the stock has been trading near $177.5 this week. The 3-Mar 177.5 calls are $2.78 and the 3-Mar 177.5 puts are $2.73. So, in the COST example, the markets are pricing in a potential 3% move either up or down in the COST stock price after the earnings announcement ($5.51/$177.5=.03).

The takeaway: earnings in the retail sector have been a mixed bag. This led to large moves in retail stock prices as well as trading opportunities in both the equities and options markets. While traders use options in different ways when trading around earnings announcements, the options market can also give a trader an idea of what potential price risk there is in the stock.