Traders shopping for retail bargains
04/20/17

Worries about the shift to online commerce have punished many retail stocks, but yesterday options traders shopped for value in the space.

Department store operator Nordstrom (NYSE: JWN) led the charge, with 5,000 May 50 calls bought for $1.31 and an equal number of May 55 calls sold for $0.27. Known as a “vertical spread,” here’s how it works:

  • Owning calls sets the price where investors can purchase a security. In this case, the level is $50.
  • Selling calls obligates them to deliver the security if a certain level is reached. In this case, the level is $55.
  • They will collect $5 if JWN closes at $55 or higher on expiration. (Buy for $50, sell for $55.)
  • They paid $1.04 net, which is the cost of the May 50 calls ($1.31) minus the credit for the May 55 calls ($0.27). That $5 potential return divided by the $1.04 outlay implies a potential profit of 381 percent.
  • JWN rose 0.98 percent to $46.53 yesterday, and needs to appreciate another 18 percent for the $55 maximum-profit level to be reached. In other words, a gain of less than 20 percent in the stock could almost quintuple their money.
  • Breakeven is at $51.04, and the position will expire worthless if the stock remains below $50.

A bet in rival Kohl’s (NYSE: KSS) hit at almost the same time, but was far more aggressive. This time, the trader snapped up 3,000 May 42.50 calls for $0.90 and sold a matching number of May 35 puts for $0.55. The resulting position is similar to owning KSS shares, with potentially unlimited losses on a drop below $35 but also no cap to its gains on a move above $42.85. Once again risk and reward go hand-in-hand. KSS rose 0.90 percent to $39.18.

It’s also probably not an accident that both of those strategies expire in May because that’s when KSS and JWN have their next earnings reports. Both companies issued weak results last quarter and have lagged the broader market by wide margins this year.

Nordstrom (JWN) 6-month chart

Source: OptionsHouse by E*TRADE

After all, bearish sentiment swirled around retailers following the 2016 holiday-shopping season. Analysts lamented how online merchants like Amazon.com (NASDAQ: AMZN) were devouring their business,1 hundreds of stores were closing,2 and some major chains were already bankrupt.3 Just this week, for instance, a report showed hedge funds heavily positioned against the sector.4

But other experts are starting to view the glass as more half-full than half-empty. Several companies in the industry have climbed since the release of monthly sales on April 6, and last week’s retail sales report showed some striking gains for traditional apparel and furniture sellers.5 Maybe these options traders think retail ain’t dead yet… especially with measures of consumer sentiment at their best levels since 2000.6

Bottom line: There’s been a ton of negativity toward retailers of late, but now traders are looking for the gloom to lift.

 

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1. CNBC: Some retailers might not survive until the end of the year, eBay CEO says. 3/20/17. Marketwatch.com: Apparel sales growth struggles to climb above 3% says NPD. 3/6/17.

2. The Washington Post: More retail stores have closed in 2017 than at the same point in 2008. 4/10/17.

3. CNBC: Retail bankruptcies march toward post-recession high. 3/31/17.

4. CNBC: Hedge funds haven't seen this negative on retail stocks since the financial crisis. 4/17/17.

5. Marketwatch.com: Retail sales post worst two-month stretch in two years. 4/14/17. U.S. Census Bureau: Advance Monthly Sales for Retail and Food Services, March 2017. 4/14/17.

6. RTT News: U.S. Consumer Sentiment Unexpectedly Improves in April. 3/17/17. CNBC: Consumer confidence soars in March to highest level since December 2000. 3/28/17.