New Trade – People of $WMT

by Dan April 2, 2015 11:18 am • Commentary

Last night on CNBC’s Fast Money program I discussed the set up in Walmart (WMT) and think that current levels represent a good long entry using $80 as a stop to the downside, watch here:

A $1 stop on an $81 dollar stock is only a little more than 1%. So some of you may be asking “is a bit tight?”

I agree. But this is where our trade structuring comes in handy.  As a long stock alternative, I want to define my risk to the $1 stop, but offer a wide range of profitability to the upside.  So here is how I am going to do it:  

TRADE: WMT ($81.10) Buy June 80/85/90 Call Butterfly for 1.35

-Buy 1 WMT June 80 call for 2.85

-Sell 2 WMT June 85 calls at .85 each or 1.70 total

-Buy 1 WMT June 90 call for .20

Break-Even on June expiration:

Profits: between 81.35 and 88.65 make up to 3.65, max gain of 3.65 at 85

Losses: up to 1.35 between 80 and 81.35 & between 88.65 and 90, with max loss of 1.35 below 80 or above 90

Rationale:  For all intents and purposes, I have set my stop at 80 with the max loss I can take being 1.35.  I cannot lose more than the premium that I spent.  The worst case scenario in the other direction for a trade like this is that I get the direction too right and the stock rallies above 88.65 and I start to lose money.

The choice of strikes is kind of simple. $80 was a massive breakout level in late 2014 to new all time highs, and it is the level the stock has re-traced to, which also corresponds with the stock’s 200 day moving average (circled, yellow line below).  I think it is safe to say that $80 is key technical support and an $80 stop more than makes sense. On the upside, $85 looks to be near term resistance, as a level the stock broke below on large volume in response to their earnings, what was prior support now becomes resistance. And obviously the prior highs just above $90 should be massive resistance:

[caption id="attachment_52455" align="aligncenter" width="600"]WMT 1yr chart from Bloomberg WMT 1yr chart from Bloomberg[/caption]

From a vol perspective, WMT options are not exactly cheap, with 30 day at the money implied vol at 15%, which could be deemed very high if the stock were to consolidate at technical support for the coming weeks:

[caption id="attachment_52456" align="aligncenter" width="600"]WMT 1yr chart of 30 day at the m oney implied vol from Bloomberg WMT 1yr chart of 30 day at the m oney implied vol from Bloomberg[/caption]

Lastly I chose June expiration as it will catch the company’s Q1 results scheduled for May 19th, which will miss May expiration.

While I am not enamored with the stock’s current growth expectations (analysts expect a 3% eps decline for fiscal 2016 on a 1% sales increase), and trading at a market multiple seems like a slight stretch, but the technical set up at key support with what is now fairly low expectations sets up for a nice risk reward trade, with defined risk. This trade is also great as a stock alternative.