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This Retailer Could Create a Big Gain for Traders Soon

This Retailer Could Create a Big Gain for Traders Soon

Retailers have had mixed results this quarter. Foot Locker, Inc. (NYSE: FL) is a retailer of shoes and apparel. The company operates through two segments: Athletic Stores and Direct-to-Customers.

The company is an athletic footwear and apparel retailer, which include businesses, such as include Foot Locker, Kids Foot Locker, Lady Foot Locker, Champs Sports, Footaction, Runners Point, Sidestep and SIX:02.

The Direct-to-Customers segment is multi-branded and sells directly to customers through Internet and mobile sites and catalogs. The Direct-to-Customers segment operates the Websites for eastbay.com, final-score.com, eastbayteamsales.com and sp24.com.

Additionally, this segment includes the Websites, both desktop and mobile, aligned with the brand names of its store banners (footlocker.com, ladyfootlocker.com, six02.com kidsfootlocker.com, champssports.com, footaction.com, footlocker.ca, footlocker.eu, runnerspoint.com and sidestep-shoes.com).

Benzinga reported,

 Foot Locker, Inc. reported a third quarter earnings beat [recently], but a sales miss sent shares plunging.

FL daily chart

Cowen analyst John Kernan reiterated a Market Perform rating but lowered his price target from $47 to $45.

The Thesis

The footwear retailer reported impressive comp growth of +5.7% year-over-year, and up from +0.8% in the second quarter.

Kernan says comp growth came largely from Nike Inc (NYSE: NKE) and Adidas AG (ADR) (OTC: ADDYY) innovation, but the company will face tougher comparisons heading into next year.

Foot Locker management said it expects fourth quarter comps to be in the low single digit range and added that moving forward, the company will provide comps and EPS guidance on an annually instead of on a quarterly basis.

Kernan said management attributed the comp guidance reduction to declining apparel and a shift in the Yeezy launch schedule, which was pulled forward to earlier in the year compared to last year.

The analyst said apparel was negatively affected by a shift away from fashion sportswear and logo, potentially a negative sign for Hanesbrands Inc. (NYSE: HBI) Champion, a brand that has enjoyed success at Foot Locker in recent months.

Foot Locker will face a difficult +9.7% comp comparison in the fourth quarter, which was driven by a +22% increase in the e-commerce channel, said Kernan.

A positive take away from Foot Locker’s quarter was a return to growth in the basketball category however, driven by a strong Jordan business, robust Air Force 1 and Air Max demand, a good sign for Nike, said Kernan.”

The sell off could mark the peak of a failed rally attempt.

FL weekly chart

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.

bear call spread

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 FL

For FL, we could sell a December 20 $40 call for about $1.69 and buy a December 20 $42.50 call for about $0.70. This trade generates a credit of $0.99, 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 in FL results in immediate income of $99 The credit received when the trade is opened, $99 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade in FL is about $151. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($99).

This trade offers a potential return of about 65% 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 FL is below $40 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 $151 for this trade in FL.