Retailers Might Be the Best Trades In The Market Right Now
For at least a few years, analysts have warned of the demise of retail (NYSE: M).
That warning has been accurate in many cases as thousands of stores have been closed and many national chains entered bankruptcy. The news, and the tone of the news, contributes to volatility in the sector and makes the stocks excellent trading candidates.
As one example, Yahoo Finance reported,
The last thing many of the nation’s most struggling retailers need is an escalation of the U.S.-China trade war, as suggested will happen next with China saying Friday it will impose $75 billion in new tariffs on the U.S. in two tranches (September 1 and December 15).
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That’s especially so for retailers such as J.C. Penney (JCP), Macy’s (M) and the like — legacy companies saddled with way too much debt, little pricing power and too many stores in the age of digital shopping. These companies are ill-equipped to raise prices to compensate for the higher cost of their merchandise as a result of a full-blown tariff war.
With next to no pricing power and costs on the rise, investors will ratchet up their concerns on the sales and debt repayment outlooks for these household name brands.
“If you are a retail CEO of a poorly run, lower rated retailer and you get tariffs you are walking out on the front porch and looking for the locusts because what else could happen next to you,” said Moody’s Investors Service veteran retail strategist Charles O’Shea on Yahoo Finance’s The First Trade.
Retailers received a reprieve earlier this month as the Trump administration said it would delay another round of tariffs on Chinese imports, notably toys, video games and some clothing to December 15. The administration cited health, safety and national security concerns for its decision.
Consumers will start feeling the tariffs.
But make no mistake, come December barring any further action the onslaught of tariffs on both sides of the pond could wallop retailers and consumers.
JPMorgan recently estimated that 25% tariffs on all Chinese could cost U.S. households $1,550 more per year.
Meanwhile, UBS said 25% tariffs on all Chinese imports could trigger 11,000-plus store closures within the next year. Previously, UBS expected 21,000 store closures by 2026 just based on the shift to online shopping.
Among the company’s reacting to the news is Macy’s (NYSE: M).
The stock is in a long term down trend and challenging important support levels.
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 M
For M, we could sell a September 20 $13 call for about $2.01 and buy a September 20 $15 call for about $0.54. This trade generates a credit of $1.47, 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 $147. The credit received when the trade is opened, $147 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $353. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($1.47).
This trade offers a potential return of about 41% 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 M is below $13 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 $353 for this trade in M.