Holidays Bring Options Opportunity

The U.S. boasts a population of world-class shoppers, who have buttressed the economy for the last few years with a seemingly indefatigable appetite for goods and services.

But even the best of champions, though the heart might still be willing, inevitably need to rest, and there is growing evidence that high energy prices and only modest wage gains are sapping the consumer's ability to keep up the record pace of spending.

Despite the fact that retail sales figures have been trending lower for the last three months, and fuel prices, which act as a tax on the consumer, remain near record highs, retail stocks have performed surprisingly well of late, with both the Retail HOLDRs (RTH) and iShares Consumer Cyclical Sector Index (IYC) approaching 52-week highs in Wednesday's euphoric postelection rally. This could leave retail stocks vulnerable to a selloff and volatile trading as we head into the all-important holiday shopping season.

The implied volatility on the options on these two retail-based exchange traded funds, or ETFs, is about 16%, which is near the low end of their near 52-week range. This presents an opportunity to establish a low-cost/low-risk bearish position through the purchase of inexpensive put options. The low implied volatility level stands in contrast to the fact that retailers are entering their most volatile time of the year in which weekly sales reports can cause significant price movement.

With the shares sitting near 52-week highs, the risk seems greater for disappointing news to trigger a sharp pullback. Buying put options gives you a bearish base from which to trade this group during what can be an active period.

Flipping Stock Against Options

Establishing a bearish (long puts) position provides the possibility of making many short-term trades at no additional risk. With implied volatilities at low levels, the ability to profitably "flip" stock a sufficient number of times to offset the time decay of the long options becomes a very attractive trading tool. Here is a basic example of how trading the underlying stock against an existing option holding might work:

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