Shoppers Are Creating a Triple-Digit Opportunity at Walmart
Trade summary: A bull call spread in Walmart Inc. (NYSE: WMT) using the August $130 call option which can be bought for about $4.10 and the August $135 call could be sold for about $2.60. This trade would cost $1.50 to open, or $150 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $150. The maximum gain is $350 per contract. That is a potential gain of about 133% based on the amount risked in the trade.
Now, let’s look at the details.
WMT has been moving up, as Barron’s reported, “…on reports it would offer a subscription service to rival Amazon Prime. Credit Suisse argues that it could turn valuable new shoppers into repeat customers.”
The report continued, “Analyst Seth Sigman reiterated an Outperform rating and $135 price target on WMT [recently], writing that his research points to strong consumer interest into a Walmart+ option should it hit the market.
“Overall, we like the idea of this subscription, the stickiness related to it, the potential for a significantly larger recurring revenue stream and incremental sales/gross profit dollars,” Sigman writes.
His research and survey of consumers show that many shoppers are receptive about a Walmart+ option, with nearly two-thirds of respondents replying they would subscribe or consider subscribing. That figure rises to 70% for 18- to 44-year-olds, a key spending demographic.
Moreover, those that already shop at Walmart were more likely to respond positively, showing that the company can draw on its strong base to boost subscriptions.
Sigman estimates there is an immediate addressable population of five million for the program, although that figure could more than double over time.
Moreover, the timing is good, as nearly half of respondents who ordered groceries online from Walmart started to do so only after the beginning of the Covid-19 pandemic. A subscription service would help keep those new customers coming back.
Of course, Walmart still has work to do, as his survey showed that consumers still prefer Amazon.com’s delivery times and online experience. Moreover, consumers seem fairly committed to the idea of free shipping without meeting a spending threshold.
That could mean lower basket sizes for Walmart, but a higher frequency of orders.
Sigman isn’t the only analyst upbeat about Walmart+.
The company hasn’t been shy about taking aim at Amazon, and the new service may help convert new consumers into longtime shoppers, especially as pandemic-related issues have stretched out some shipping times for Amazon Prime goods—making click-and-collect options at bricks-and-mortar stores more attractive to some.”
Shares of WMT have retraced their bear market losses and appear positioned for additional gains.
A Specific Trade for WMT
For WMT, the August options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An August $130 call option can be bought for about $4.10 and the August $135 call could be sold for about $2.60. This trade would cost $1.50 to open, or $150 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 $150.
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 WMT, the maximum gain is $350 ($135- $130= $5; 5- $1.50 = $3.50). This represents $350 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $150 to open this trade.
That is a potential gain of about 133% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying WMT 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 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.