Retail Sales in Spotlight

Consider using calendar spreads to place any bets on the sector.
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This column was originally published on RealMoney on Oct. 5 at 9:44 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Retailers' monthly same-store-sales numbers will take center stage today, as investors get a read on not only how much consumers are spending, but also where they're spending it.

The overall numbers for September suggest that the economy remains on sound footing, and the recent decline in fuel prices has helped maintain traffic at most stores. But it's important to identify the winners and losers.

Once again, the best groups seem to be big general merchandisers such as

Kohl's

(KSS) - Get Report

,

Target

(TGT) - Get Report

and

J.C. Penney

(JCP) - Get Report

and boutique apparel retailers like

American Eagle

(AEOS)

and

Children's Place

(PLCE) - Get Report

. They're putting up better-than-expected numbers, while deep discounters like

Wal-Mart

(WMT) - Get Report

and

Costco

(COST) - Get Report

are at the low end of their expected ranges.

Retail stocks had a great day yesterday, with many of the stocks hitting new 52-week highs. The challenge will be determining what's already baked into the prices. Of course, using options can help create positions that have a lower-risk profile than outright ownership of the stock.

The strategy I'm looking at across the sector is to use calendar spreads. That is, sell near-term options and buy options with a longer expiration date. For example, sell October or November options and simultaneously buy options with December or January expiration. The sale of the front month helps reduce the cost and, therefore, the maximum risk of the position. The time value of the nearer-term options sold short will decay at a faster rate than the longer-dated options you own, which helps mitigate the negative impact of owning a decaying asset. If you use strikes that are out-of-the-money it also will have a directional component -- that is, benefit from an increase (or decrease) in the stock price.

The reasoning for employing a calendar spread strategy now is that after today's numbers, the implied volatility of the options should decline, making these relatively inexpensive positions to establish over the next week.

But with the next big catalyst for price movement coming in mid-November as holiday sales forecasts start to come into focus, implied volatility for the December and January options should creep back up as shopping days approach their year-end peak.

Remember as a net debit position, long calendar spreads will benefit from an increase in IV in the longer-dated options.

For example, if one is bullish on

Best Buy

(BBY) - Get Report

with shares trading around $56.50, one could sell the October $60 calls and buy the December $60 calls for a net debit of around $1.80 for the spread.

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 appreciates your feedback;

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