Considering Our Options – $XRT: Holiday Hangover

by CC December 15, 2014 2:49 pm • Commentary

I wanted to circle back to a trade we have on in the XRT (retail ETF) from Nov 21st (here) as it’s working well but we’ll likely make a move on it in the next few days. To recap, we looked to play for a consolidation that was then followed by weakness in the New Year in the retail stocks. We did this in the form of a calendar put spread. Here was 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

Now wit the stock only slightly lower (92.55) this structure is worth about $2.70 (paid 1.70). The December puts that we are short are only worth about .25 with only a few days to go until expiration and they account for about half of the mark to market profits at this point. The other half comes from the fact that vol has ticked higher in March. The March 90 puts are worth about $2.95 (paid $2.40) even though the stock is only down about 40c since entry. This is the effect that rising vol has on a calendar spread. We bought that March vol near its recent lows:

Screen Shot 2014-12-15 at 12.21.46 PM
3 month IV vs HV from LiveVol Pro

So with the structure nicely profitable it’s time to look at how we’re going to manage this into Friday’s expiration. We like the set-up for the ETF to possibly go lower in the early part of the New Year. So we’ll want to hold onto those March puts. But we’re also not crazy and don’t want to risk the profits we already have on a naked March put at higher vol than when we entered. Therefore we’ll look to roll the short put portion of the structure this week. We’ll close the December 90 put as cheaply as possible, and then sell the Jan 90 put (or if the market is lower than it is now, possibly a lower strike). After that roll we’ll have the Jan/March put calendar on for next to nothing.





original post:

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.

XRT ytd chart from Bloomberg
XRT ytd chart from Bloomberg

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.