On a few occasions of late I have described my aversion to stepping in front of what appeared to be an impending breakout in retail stocks heading into the holiday season (reprinted below). But with the breakout having occurred in many of the largest cap retail stocks, and with most earnings / forward guidance out of the way, it makes sense to consider the trade set up once we get past the hotly anticipated shopping days in the coming week (Black Friday and Cyber Monday) and into the home stretch to the Christmas holiday. I have a couple anecdotal take-aways. First, the pre-Black Friday deals that I am reading about lead me to believe this will likely be the most promotional holiday season on record, which doesn’t bode well for margins. Also, no matter what your opinion is of Apple (AAPL) as a stock, the company’s products will likely dominate big ticket purchases in electronics with recently refreshed iPhones but more importantly, new iPads and what is sure to be a heavy push on Beats headphones and speakers.
As I said in yesterday’s MorningWord:
While I have been very wrong as a pundit to voice negativity about chasing some of these stocks into and out of Q3 results (Macy’s 2 weeks ago, with Best Buy today’s example), I assume Q4 holiday sales on a gross basis will be as good as it gets for a while. I suspect margins will be atrocious, and Q1 commentary on the space will be one of tempered forward expectations for the first half of 2015.
If the stock market is in fact a discounting mechanism, then the stellar holiday sales are probably already priced into most of the stocks making new all time highs, with valuations stretched above a market multiple. So if you are chasing runaway breakouts when the news flow and sentiment can’t be better (heading into a make or break season) it could be time to discount that enthusiasm, recognizing the potential for a post holiday hangover. Oh and one more thing, remember the weather in Q1 and the number it did on Q1 GDP, well things ain’t shaping up a whole lot better with the polar vortex in the Northeast and so we can expect to hear that excuse once again.
To sum up, Q4 sales may be hot but I assume profitability will be concentrated in Cupertino and I think it is safe to say that the news overnight about heightened stimulus abroad suggests that the global economy is weaker than many think, which was also a concern of the Federal Reserve from their latest meeting minutes. Much like last year I am expecting downward volatility in Q1 resulting from global growth concerns, and investor concern over our ability to de-couple from the rest of the world.
Despite lower oil, I think Q4 sales may be as good as it gets for many retailers here in the U.S. and I want to set up a trade where I sell some short dated premium to help finance owning longer dated puts that will capture most Q4 results/Q1 guidance in Jan and Feb.
So here is the trade:
XRT ($92.93) Buy Dec / March 90 Put Spread for 1.70
-Sell 1 December 90 Put at .70
-Buy 1 March 90 Put for 2.40
Break-Even on December Expiration:
Profits in this trade are maximized at $90 in the etf on Dec expiration. at that point the trade can either be closed for a profit or rolled into a further expiration on the short put side of the calendar or a simple vertical put spread within March expiration. Losses in this stucture will be if there’s a large move in either direction before December expiration. Either in the form of a parabolic breakout to the upside or a crash to the downside.
Rationale: At today’s highs the XRT was up 16% from the October 15th lows but has given up most of today’s early gains. I would expect some sort of consolidation of recent gains as many components have made runaway breakouts that have already incorporated a lot of good news. $90 seems like a very logical level to pull back and consolidate at the prior breakout level.
If the etf were to come back to $90 prior to Dec expiration I would look to cover Dec puts and sell a lower strike put in Jan or Feb, making a calendar, or more turn into a vertical by selling a lower strike put in March.
[hr]
Previous Post Nov 20th, 2014: MorningWord 11/20/14: Discount Window $XRT
I am fairly certain that whatever type of market participant you are (active, passive, or have merely a viewer of financial TV) then you have heard the statement “the stock market is a discount mechanism”. What this means is that current stock prices incorporate a good bit of future expectations. There is no take it to the bank method to make money off of this sort of wisdom but there are examples where price action of an index/sector or that of its components can be fairly telling about what’s to come. For example, a week ago in this space, I took a quick look at the breakout in retail stock etf XRT (MorningWord 11/13/14: Retail Therapy) despite some high profile earnings disappointments from COH, KORS, KSS, GPS, ANF (to name a few):
The action in the S&P retail etf XRT was impressive. After a year long consolidation between $80 and $90 it looks like it’s broken out:
Obviously there are some seasonal factors at play here. For the next few weeks I see little reason to try to step in front of the retail train on either side as investors seem to want to express newfound optimism about the U.S. economy amidst lower energy prices and it would be dumb to short but at the same time it’s probably too late on the long side. My fairly simple stance on the recent retail rally is that it is more a matter of positioning. Investors have been crowded into retail stories that have been working like COST, HD, NKE, TJX & UA but have recently woken up to laggards like M, TGT & WMT which are valued at significant discounts. And it hasn’t been a rotation from within the sector but likely out of energy and into broader retail, as evidence by the XRT breakout.
Despite that observation last week I have been unable to take a more bullish position on retail stocks, both as a trader, and as a pundit. On numerous situations over the last couple of weeks on CNBC’s Fast Money and Options Action I have found myself taking the other side of what I have perceived to be overly optimistic near term sentiment that is largely driven by seasonal factors. It is my strong belief that we are likely to see the most promotional holiday selling season on record, coupled with the fact that Apple (AAPL) is likely to take a huge chunk of the big budget items with sales of new larger iPhones and Beats headphones and speakers.
Yesterday’s action in Lowe’s (LOW) and Target (TGT) was astounding. Both stocks massively outperformed the implied moves, and the 4 and 8 qtr averages, with LOW closing at new all time high, and TGT about 1% away.
LOW up 6.37%:
TGT up 7.39%:
Oh, and the runaway breakout in WMT last week to all time highs was fairly epic:
So what is this price action discounting? I think it is safe to say that all three stocks have seen their earnings multiples expand with just slightly better incremental financial results coming off of a period of very poor sentiment.
While I have been very wrong as a pundit to voice negativity about chasing some of these stocks into and out of Q3 results (Macy’s 2 weeks ago, with Best Buy today’s example), I assume Q4 holiday sales on a gross basis will be as good as it gets for a while. I suspect margins will be atrocious, and Q1 commentary on the space will be one of tempered forward expectations for the first half of 2015.
If the stock market is in fact a discounting mechanism, then the stellar holiday sales are probably already priced into most of the stocks making new all time highs, with valuations stretched above a market multiple. So if you are chasing runaway breakouts when the news flow and sentiment can’t be better (heading into a make or break season) it could be time to discount that enthusiasm, recognizing the potential for a post holiday hangover. Oh and one more thing, remember the weather in Q1 and the number it did on Q1 GDP, well things aint shaping up a whole lot better with the polar vortex in the Northeast and so we can expect to hear that excuse once again.