Retail Might Not Have Died Last Year
Source: Williams-Sonoma, Inc.
After a number of bankruptcies last year, analysts began compiling lists of companies that had failed in recent years. With the number of individual store closings reaching into the thousands, it became popular to proclaim the death of retail.
Well, the retail sector has recovered. The chart below shows the SPDR S&P Retail ETF (NYSE: XRT) and the ETF is breaking out to new highs.
New highs confirm a bullish outlook for the stocks that are remaining in the sector. There have been some brands that didn’t make it but the sector now appears to be strong.
Earnings Reports Confirm Strength of Some Familiar Names
Traders have been buying shares of retailers that delivered strong earnings reports. Among those stocks is Williams-Sonoma, Inc. (NYSE: WSM) which reported its quarterly results recently. The news was good, according to Zacks, which reported that the company,
“…came out with quarterly earnings of $0.77 per share, beating the Zacks Consensus Estimate of $0.68 per share. This compares to earnings of $0.61 per share a year ago. These figures are adjusted for non-recurring items.
This quarterly report represents an earnings surprise of 13.24%. A quarter ago, it was expected that this seller of cookware and home furnishings would post earnings of $0.57 per share when it actually produced earnings of $0.67, delivering a surprise of 17.54%.
Over the last four quarters, the company has surpassed consensus EPS estimates three times.
Williams-Sonoma, which belongs to the Zacks Retail – Home Furnishings industry, posted revenues of $1.28 billion for the quarter ended July 2018, surpassing the Zacks Consensus Estimate by 1.28%.
This compares to year-ago revenues of $1.20 billion. The company has topped consensus revenue estimates four times over the last four quarters.”
After an earnings beat, analysts often raise their expectations for a company. Right now, for WSM, the current consensus earnings per share (EPS) estimate is $0.95 on $1.35 billion in revenues for the coming quarter and $4.23 on $5.61 billion in revenues for the current fiscal year.
If analysts raise estimates, the stock should break out to new highs. The chart below shows the company is close to new highs.
For now, June’s high in the stock is likely to be resistance. A break above that would be expected to lead to a short term up move in the price. The recent gain on the earnings report actually changed the outlook for the stock, moving from a bearish to a bullish pattern.
A Trade for Short Term Bulls
As with the ownership of any stock, buying WSM 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.
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 WSM
For WSM, the September 21 options allow a trader to gain exposure to the stock.
A September 21 $75 call option can be bought for about $1.22 and the September 21 $80 call could be sold for about $0.27. This trade would cost $0.95 to open, or $95 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 $95.
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 WSM the maximum gain is $4.05 ($80 – $75 = $5.00; $5.00 – $0.95 = $4.05). This represents $405 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $95 to open this trade.
That is a potential gain of about 325% 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.