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Virtual Stores Might Not Save Retailers

Virtual Stores Might Not Save Retailers

Retailers are struggling and many companies are looking at unusual ideas to boost business. Among the biggest problem retailers face is that Amazon has made almost everything accessible and with free delivery for many customers, physical stores are at a disadvantage.

Shopping at a physical store requires customers to leave home, driving or taking public transportation to the store’s location and then getting merchandise home. This is proving to be a significant hurdle for many shoppers when products are competitively priced online.

To stay in business, retailers are experimenting. Among those experiments is the decision by Nordstrom, Inc. (NYSE: JWN) to open a store without inventory.

Experiences to Attract Customers

The company announced on Monday that it is preparing to introduce a new line of stores. The stores will be called Nordstrom Local and will be significantly smaller than traditional Nordstrom locations. The new stores will be 3,000 square feet, instead of a typical Nordstrom store size of 140,000 square feet.

To reduce the size of its stores, Nordstrom Local will be much different from other retailers. The store will not stock inventory. The first store, set to open in West Hollywood, California, on October 3, is expected to have eight dressing rooms where shoppers may try on clothes.

The store will not have inventory available for purchase in stock. Instead, Nordstrom will be pulling merchandise from other mall-anchored stores and from its website.

“Shopping today may not always mean going to a store and looking at a vast amount of inventory,” Shea Jensen, Nordstrom’s senior vice president of customer experience, said in prepared remarks. “It can mean trusting an expert to pick out a selection of items.”

The store will provide a personalized shopping experience. Personal stylists will be doing most of the work at Nordstrom Local, curating outfits for shoppers and trying to ease the stress many face of finding the perfect look.

Nordstrom Local shops will also have “bars” in stores, where thirsty shoppers can order juices or wine, the company said.

Other experiences at Nordstrom Local locations will include manicures and on-site tailoring. Nordstrom’s “Buy Online, Pick-Up In-Store” service will also be available.

For those needing clothes is a hurry, same-day delivery will be an option for shoppers who visit Nordstrom Local and select items before 2 p.m.

Joining a Trend While Leading Its Segment 

Reducing the size of physical stores has been a trend among retailers, especially among retailers looking or ways to increase profitability. The struggling retailer Sears, for example, is also experimenting with its smaller-format store concept, which will only sell appliances and mattresses.

Smaller Target locations are being introduced in large cities, allowing the retailer to enter new markets where larger store sizes are not possible.

Nordstrom’s move could be a significant change for department stores. According to CNBC, Nordstrom is often considered by analysts to be the best of its class, setting the pace for the rest of the industry. Recent sales demonstrate that leadership position. During the second quarter, Nordstrom posted same-store sales growth of 1.7%, easily outpacing Street expectations.

Nordstrom, Inc. is recognized as a leading fashion specialty retailer based in the U.S. The company was founded in 1901 as a shoe store in Seattle and has grown to operate 356 stores in 40 states, including 121 full-line stores in the United States, Canada and Puerto Rico; 224 Nordstrom Rack stores; two Jeffrey boutiques; and two clearance stores.

Additionally, customers are served online through Nordstrom.com, Nordstromrack.com and HauteLook. The company also owns Trunk Club, a personalized clothing service serving customers online at TrunkClub.com and its seven clubhouses. Nordstrom, Inc.’s common stock is publicly traded on the NYSE under the symbol JWN.

While Nordstrom is generally referred to as a leader in the department store industry, its stock market valuation has not usually confirmed this. Shares of JWN have historically traded at a discount to its industry.

Over the past five years, for example the average price to earnings (P/E) ratio for department stores has been 19.3, above JWN’s average of 18.8. Now, however, JWN is trading at a premium to its industry with a P/E ratio of 21 compared to an industry average of 16.

One reason for the premium could be simply that JWN is expected to deliver growth. Analysts expect earnings per share (EPS) of $2.97 for the current fiscal which ends in January 2018. Based on that estimate, the stock is trading at about 13 times earnings.

However, JWN has a history of failing to meet expectations. The company has reported earnings that were below analysts’ estimates six times in the past twelve quarters. Given this history, it could be best to trade with caution in the stock, expecting a pullback rather than a rally.

Caution is also warranted given the stock’s long term downtrend which dates back to 2015. Although there is room for optimism that support has been found, traders should wait for a confirmed uptrend before buying.

A Specific Trading Strategy

To trade a potential decline in the stock, a trader could buy a put. For JWN, it’s not surprising that put options are relatively expensive. The stock is in a downtrend and its sector is especially weak in the current market environment.

The high price of the put option suggests an alternative strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility. In this case, with a bearish outlook, a call option should be sold.

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 is important to consider is the bear call spread. This trade 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, so this strategy will always generate a credit when it is opened.

The risk profile of this trading strategy is summarized in the diagram below.

Source: The Options Industry Council

The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.

The maximum potential gain with this strategy 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.

A Bear Call Spread in JWN

For JWN, we could sell September 15 $45 call for about $0.40 and buy a September 15 $47.50 call for about $0.05. This trade generates a credit of $35, which is the difference in the amount of premium for the call that is sold and the call that is bought multiplied by 100 since each contract covers 100 shares. That is the maximum potential profit on the trade.

The maximum risk on the trade is $65. The risk is found by subtracting the difference in the strike prices ($100) and then subtracting the premium received ($35).

This trade offers a return of about 53% for a holding period that is less than one week. This is a significant return on the amount of money at risk. This trade delivers the maximum gain  if JWN is below $45 when the options expire, a likely event given the stock’s trend.