Amazon Provides Another Trading Opportunity
Amazon.com has become a primary force in the stock market. The company’s stock is a market leader and is one of the stocks analysts focus on as part of the FANG group. FANG includes Facebook, Amazon.com, Apple, Netflix and Google.
Analysts believe these companies are reshaping commerce and in many ways, they are. Facebook is changing the way news is delivered, for example, and is now an important source of information when disaster strikes. The company also changed the way friends communicate.
Apple, of course, makes the devices that enable this revolution in commerce. Google is simply everywhere in the new economy. Search results provide an opportunity for ad placement and data collection, for example. And, Netflix is changing the way entertainment is enjoyed.
Amazon, at least in recent months, has become the driver of big stock moves in competitors or potential competitors. Several times, we see a rumor that Amazon is considering entering a business area. Or, sometimes, there is actual news from Amazon. Stocks dive on the assumption it’s impossible to compete with Amazon.
Sometimes, It Is Possible to Compete With Amazon
On Thursday, Kroger Co.’s (NYSE: KR) delivered their latest quarterly earnings and traders were surprised that Amazon’s purchase of Whole Foods hadn’t affected Kroger’s grocery business as much as expected.
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The grocery chain delivered better than expected results with earnings per share of $0.44, four cents better than analysts’ expectations. Sales of$27.7 billion were well above expectations which had been set at $24.5 billion in total sales.
What the company calls “identical supermarket sales”, more commonly referred to as same store sales, grew by 1% in the third quarter. This was also better than expected. Analysts had been looking for same store sales to increase by 0.9%.
“This quarter shows that by investing for the future, our business continues to improve and gain momentum,” CEO Rodney McMullen said in a statement.
Kroger’s strategic plan to refine its food products, dubbed Restock Kroger and unveiled in October, is “off to a great start,” he added. “We continue to accelerate our digital and ecommerce offerings, to grow Our Brands, to lower prices for customers, and to invest in our associates.”
The company has been adapting to the changing consumer environment even before Amazon entered the grocery space. During the quarter, Kroger announced two new private label brands in food products and a floral line, Bloom Haus.
The company also plans to launch an apparel line next year. Kroger also noted in its earnings release that it’s investing $500 million in employee training over the next three years and hiring some 14,0000 part-time workers for the holiday season.
McMullen suggested that the company is confident about the fourth quarter after posting a stellar Black Friday.
“The holidays are always Kroger’s time to shine. In fact, we had our best ever Black Friday results for general merchandise, led by record sales at [regional store brand] Fred Meyer” he said in the statement.
Kroger is also making progress on its previously announced plans to expand self-checkout, continue to personalize coupons and develop tools for customer traffic in stores.
To further improve its focus on big stores, the company is in the process of selling more than 800 convenience stores it owns across the country, operating under the brand names Turkey Hill, Loaf ‘N Jug, KwikShop, Tom Thumb and QuickStop. News of a deal is expected soon.
Traders React to the News That Kroger Can Compete With Amazon
Kroger shares gained almost 10% on the news. This partly reverses the decline seen when Amazon entered the grocery business.
The chart shows the stock appears to be at the beginning of a new up trend that could carry the price back towards $30 where resistance should be expected.
That indicates traders should consider strategies that provide bullish exposure to the stock.
To benefit from potential gains in KR that are expected over the next few weeks to months, an investor could buy shares of the company. This requires a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
A Specific Trade for Kroger
For KR, the December 15 options allow a trader to gain exposure to the stock through the expected period of seasonal strength.
A December 15 $27 call option can be bought for about $0.55 and the December 15 $29 call could be sold for about $0.10. This trade would cost $45 to open since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $45.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in KR the maximum gain is $1.55 ($29 – $27 = $2.00; $2.00 – $0.45 = $1.55). This represents $155 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $45 to open this trade.
That is a potential gain of equal to 244% of the amount risked in the trade. The trade could be closed early, immediately after the earnings announcement, if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.