Walmart Could Deliver a 77% Gain
Trade summary: A bull call spread in Walmart Inc. (NYSE: WMT) using the November $145 call option which can be bought for about $4.10 and the November $150 call could be sold for about $2.30. This trade would cost $1.80 to open, or $180 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 $180. The maximum gain is $320 per contract. That is a potential gain of about 77% based on the amount risked in the trade.
Now, let’s look at the details.
WMT has a market cap of more than $400 billion. Stocks of that size rarely make large short-term moves. But recent news highlights a potential opportunity in the stock.
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Barron’s reported that “Walmart stock has jumped 22% in 2020, and Jefferies argues there’s more than one way for the retail giant to keep notching gains.
Analyst Stephanie Wissink reiterated a Buy rating and $165 price target on Walmart (ticker: WMT) on Wednesday as she looks at the company’s ever-expanding ecosystem and how it might propel growth.
She notes that Walmart, like other retailers, responded to this year’s delayed Prime Day event from Amazon.com (AMZN) with its own discounts of about 30% to 50%, focused on electronics and toys, along with kitchen and home goods. The discounts appeared to be roughly consistent with 2019 level, she adds.
Wissink writes that Walmart’s warehouse Sam’s Club division extended its credit-card program with Synchrony Financial (SYF), which should add “benefits to create incremental value for Sam’s Club members.” The discount model has been especially successful in 2020, with Costco Wholesale (COST) rising nearly 30% year to date, and BJ’s Wholesale Club Holdings (BJ) soaring more than 80%.
Elsewhere, she notes, recent consumer surveys show that Walmart has earned goodwill for its handling of the Covid-19 crisis, as it was “cited as a top 3 retailer for how well it has responded to the pandemic.”
It could also benefit from how the virus has changed shopping habits, as consumers are still prioritizing essentials, using omnichannel options, and plan to continue shopping online. Walmart’s huge store base and its subscription service Walmart+, which includes grocery delivery, fit squarely with these trends.
It’s also worth noting that the company is investing in Ninjacart, an India-based business-to-business fresh produce supply chain that connects merchants, farmers, and producers to retailers, with Flipkart. That fits with Walmart’s renewed focus on higher-growth segments of its business.”
After rallying significantly, WMT has been stalled, forming a consolidation pattern.
The longer-term chart below using weekly data highlights the pattern of rally and consolidation that has been in place for more than three years.
This is bullish and the stock could continue this trend for some time.
A Specific Trade for WMT
For WMT, the November 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.
A November $145 call option can be bought for about $4.10 and the November $150 call could be sold for about $2.30. This trade would cost $1.80 to open, or $180 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 $180.
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 $320 ($150- $145= $5; 5- $1.80 = $3.20). This represents $320 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $180 to open this trade.
That is a potential gain of about 77% 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 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.