Protect Against Falling Retailers
Here we are sitting on the cusp of spring, some six weeks after the troublingly accurate Punxsutawney Phil sentenced us to an extended winter. The new season surely will bring the annual rites -- the swallows will arrive at Capistrano, crocuses will burst forth and retailers will blame the weather when sales run below expectations. But you can use options to cover your assets in this vernal deluge.
To be sure, not all retailers will find the coming weeks inclement, but I am certain there will be a handful of companies that cite unseasonable weather as causing a sluggish start in sales of their spring line. The weather is always too hot or too cold for underperforming companies. But the early disappointments could be greater and wider than usual this year, with temperatures in the Northeast sticking stubbornly below 40 degrees so far this month and record high gas prices taxing the consumer, among other headwinds. My early spring forecast calls for a 65% chance of a precipitous selloff in some part of the retailing region sometime during the next four weeks.
Options Umbrella
Strapping on some sensible options positions can protect you from a shower of warnings. The premiums on the options of many retailers are running at relatively low levels, so the purchase of some put options or a simple spread affords not only a nice safety umbrella but could even yield some opportunities for short-term profits. To limit risk in this search for ideas, I scanned for stocks whose options are currently trading at least 20% below their six-month average implied volatility. The other criteria for making the short list included some basic chart and technical analysis and, subjectively, my sense of what's selling now.
The first name that caught my eye was
Kohl's
(KSS) - Get Report
, an old nemesis of mine. I've never liked this retailer and probably never will, but as Inspector Clouseau told his ever-playful sidekick Kato, "There is a time and place for everything;" and with Kohl's having failed to close above resistance at $54, now is the time to look at establishing a short position.
Shares of Kohl's have jumped nearly 19% in the last three weeks, and this recent rally represents a pretty significant breakout from a nearly two-year-long downtrend, so I am not outright bearish. But I do think the shares are vulnerable for a pullback. The company indeed has gotten many of its cost issues and inventory problems down, but it has yet to resume consistent same-store sales growth. With heated competition from the likes of
Target
(TGT) - Get Report
and newly beefed-up combinations in
Kmart
(KMRT)
and
Sears
(S) - Get Report
and
Federated Department Stores
(FD)
and
May Department Stores
(MAY)
, I think sales will come in below expectations for March and April periods, causing the stock to retest its breakout point at the $47 level.
Kohl's options are sporting an implied volatility of just 25%, which is just above the 52-week low of 23% hit earlier in the month. This makes an options buy attractive because it should eliminate any "vega" risk. Because I want to have a position that takes me through the company's next earnings announcement, scheduled for May 12, I'd like to buy May options, which will be listed Monday after the March contract expires today. If you are itching to get the trade on, you can look at the April options, which will cost slightly less and leave you the ability to roll forward in time.
Assuming Kohl's is still trading around $52 on Monday, I would look to buy the May $55 put for around $3.60 per contract. If KSS reaches the target of $48, the put will have a minimum value of $7, or nearly a 100% gain. The break-even point lies at $51.40, and I'd stop out if Kohl's closes above $54, which should limit my risk to no more than a $2 loss.
Some other names whose puts I think represent a decent risk/reward include
Limited Brands
(LTD)
,
Urban Outfitters
(URBN) - Get Report
,
Timberland
(TBL)
and
Hot Topic
(HOTT)
. On Hot Topic, which has slid 11% in the last three days, I'd wait to see if it can bounce back up near $22 per share before beginning to buy any put options.
Of course, if you don't want to pick individual issues, buying puts on the
Retail HOLDRs
(RTH) - Get Report
can be a good way to go. The options on this ETF remain very inexpensive, with an implied volatility of just 13%, making this a good way to get protection or place a bearish bet on the sector.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to
steve.smith@thestreet.com.