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More Proof of the Retail Revival

More Proof of the Retail Revival

Source: Dillard’s.com

Retailers filed bankruptcy at a rapid pace in 2017. It was troubling to many analysts who questioned if the sector could survive. In hindsight, it now appears that the analysis was overblown. The bankruptcies may have been a shakeout of weak hands and the remaining retailers could be long run winners.

Last week, Macy’s (NYSE: M) reported surprisingly strong sales and earnings results for the first quarter of fiscal 2018. The stock jumped on the news.

M daily chart

Macy’s grabbed headlines but another retailer, Dillard’s (NYSE: DDS), also delivered strong results.

In the first quarter, Dillard’s reported a 2% increase in comparable-store sales. Total revenue rose 2.6% to $1.49 billion. This marked the company’s second consecutive quarter of positive comp sales, following a long stretch of comp sales declines.

According to analysts, “Dillard’s recent sales trajectory has roughly mirrored that of Macy’s. Last quarter, Macy’s posted a 4.2% increase in comp sales, but that comp sales gain would have been approximately 1.7% excluding a shift in the timing of a major promotional event. This was also the second straight quarter with a comp sales increase for Macy’s after a long dry spell.

However, Dillard’s earnings recovery is likely to be less durable than that of Macy’s, because it depends primarily on a recovery in consumer spending. By contrast, Macy’s has been making big investments in order to drive more customers to its stores and e-commerce site, which could drive a more sustainable upturn in its business.

The solid comp sales results — along with tax savings related to the tax reform legislation passed in late 2017 — drove big increases in earnings per share (EPS) for both Dillard’s and Macy’s. Dillard’s EPS surged 36% year over year to $2.89. Meanwhile, Macy’s reported that adjusted EPS nearly doubled last quarter, rising from $0.26 to $0.48.”

Although the stock rallied, there are signs the rally could stumble. Dillard’s EPS growth was driven entirely by the lower tax rate and the impact of stock buybacks, which reduced its share count.

But, the rally in the stock price led to an improvement in the technicals.

DDS daily

Now, traders might be wary of jumping in, worried that the stock could pull back after the sharp rally on the earnings news.

A Trade for Short Term Bulls

As with the ownership of any stock, buying DDS could require 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.

bull call spread

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.

This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for DDS

For DDS, the June 15 options allow a trader to gain exposure to the stock.

A June 15 $84 call option can be bought for about $1.90 and the June 15 $85 call could be sold for about $1.35. This trade would cost $0.55 to open, or $55 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 $55.

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 DDS the maximum gain is $0.45 ($85 – $84 = $1.00; $1.00 – $0.55 = $0.45). This represents $45 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $55 to open this trade.

That is a potential gain of about 81% based on the amount risked in the trade. The trade could be closed early 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.