Amazon’s Latest Move Sets Up a Potential Trading Opportunity
Amazon never seems to stand still. It consistently identified new business opportunities and the stocks in the industry tend to react in a predictable way. The Wall Street Journal reported,
“Amazon.com Inc. has challenged grocers by pushing them to lower prices and expand their delivery options. Now the company’s latest plans threaten to steal sales of some of the industry’s more profitable products.
The e-commerce giant plans to launch urban grocery stores that could offer a spectrum of goods that includes beauty products alongside food, The Wall Street Journal has reported. Beauty products represent a small portion of supermarket sales but tend to offer higher profits than more traditional items.
The move couldn’t come at a worse time for grocers, which have been focused on building up digital selling operations to compete with Amazon online.
Amazon has an aggressive timeline for the store openings, with the first on track to debut as soon as the end of this year, according to people familiar with the matter. The company aims to open dozens of locations in major cities, including Los Angeles, Chicago, and Washington, D.C., the Journal has reported.
Much could change about Amazon’s plan, but initial details about the size and layouts of the stores—smaller than most traditional supermarkets but bigger than many convenience stores—suggest they could pose a competitive threat to traditional supermarket chains like Kroger Co. (NYSE: KR) as well as mass merchants like Walmart Inc. and Target Corp., according to food industry analysts.
Amazon has pushed for leases that won’t restrict what it sells in its new chain, opening it to offer cosmetics and skin- and hair-care products as well as other retail items, according to people familiar with the matter.
Beauty items offer high margins for grocers, and Amazon has expanded its array of such products under various labels. Health and personal-care items are Amazon’s largest source of consumer-product sales online, with roughly $5 billion in sales last year, according to e-commerce data analysts Edge by Ascential.
The timing of Amazon’s store development comes during a difficult period for the roughly $1 trillion food and consumer-product retail sector, which already deals with low margins and extreme competition. Grocers have been struggling to keep shoppers coming to their stores, while Amazon’s quick, low-cost delivery has eaten into sales of shelf-stable goods and bulky items sold at supermarkets, market analysis shows.
“Amazon just keeps on pushing the finish line further ahead for the others,” said Phil Lempert, a grocery consultant.
An Amazon spokeswoman declined to comment and said the company doesn’t comment on rumors or speculation.
Grocery industry executives said it is too early to know how traditional supermarkets would alter their operations in light of Amazon’s latest grocery store push.
In the past two years, however, many have been forced to change some fundamental aspects of their operations, from staffing to the way they organize their stores, often to facilitate online ordering and compete with Amazon.
Walmart, Target and Kroger, for instance, have sped up investments in technology and online selling strategies, and in some case have sacrificed profits to offer delivery and digital pickup for a growing number of markets.
Some also have cut back at opening new stores. Walmart reiterated last month that it would open fewer than 10 stores in its current fiscal year, while looking to double the number of locations offering same-day grocery delivery and adding 1,000 grocery pickup places.
“Amazon forced them all into delivery…and then this,” Mr. Lempert said, referring to the company building stores.
A Target spokesman declined to comment. A Walmart spokesman pointed to its chief executive’s comments last month on the company’s efforts to compete online and in stores. “We’re meeting the changing needs of customers and delivering solutions that are increasing customer engagement,” CEO Doug McMillon said.
Kroger, the U.S.’s largest supermarket chain by stores and sales, has scaled back on new store plans. The company also is spending tens of millions of dollars to build a network of automated warehouses for online grocery services, while trying to expand in higher-margin mass merchandise with a clothing line.
A Kroger spokesman said the grocer has a winning strategy. “We are transforming from grocer to growth company,” he said.
Following the Journal’s report about Amazon’s store plans on Friday, Kroger’s shares dropped as did Walgreens Boots Alliance Inc., which recently struck a deal to put mini-Kroger stores in some locations, was also down.
Amazon has a long-term initiative to build out a physical grocery presence, and at one point envisioned more than 2,000 brick-and mortar stores in different formats. It is a bet that shoppers still want to buy groceries, personal-care items and other consumer products at physical stores.
Though more shopping is expected to migrate online, less than 5% of the roughly $1 trillion in annual U.S. food and consumer product shopping is done over the internet now, market research shows.
With its new stores, Amazon could market itself as a food seller to a greater range of consumers than those currently buying sundries online. It also broadens its reach beyond the higher-income shoppers who tend to frequent Whole Foods Market, which it bought two years ago.
It isn’t clear whether the new stores would carry the Amazon name, but they are expected to be distinct from Whole Foods.
The latest foray into physical retail isn’t without risks. Those knowledgeable about the company’s plans say the stores could average 35,000 square feet—a size that industry consultants say could be tough to make appealing to consumers because it is too small for big shopping trips but larger than the typical quick convenience store run.
“The economics of a store that size are tough,” said Bryan Gildenberg, chief knowledge officer at Kantar Consulting, adding that Amazon will need to locate the stores in high-traffic areas to drive volume.”
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in KR
For KR, we could sell an April 18 $29 call for about $1.25 and buy an April 18 $31 call for about $0.50. This trade generates a credit of $0.75, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $75. The credit received when the trade is opened, $75 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $125. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($0.75).
This trade offers a potential return of about 60% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if KR is below $29 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $125 for this trade in KR.