Retail earnings for the holiday period have gotten underway in earnest this week, which for the most part were disappointing when you consider Walmart’s (WMT) guide down for the current year and Nordstrom’s (JWN) disaster this morning.
Next week we will get results and guidance from Best Buy (BBY), Dillards (DDS), JC Penny (JCP), The Home Depot (HD), Lowe’s (LOW) Macy’s (M). Office Depot (ODP), Target (TGT) and TJ Maxx (TJX).
It’s been my view that U.S. consumers, while showing healthy relative strength to those in other countries have not had the windfall that many economists might have expected from the crash in oil prices, as the unintended consequences from commodity deflation has reared its ugly head in many other parts of our economy, and the savings at the pump have merely offset other adverse factors affecting U.S. consumers.
Despite all that, the secular shift in consumer behavior as it relates to how they shop has done a number on many retail business models, causing massive investments in omni-channel selling models to better compete with the likes of Amazon.com.
And what if oil prices were to go up for the wrong reasons, like the often rumored production cut? That would not be the result of greater demand so it wouldn’t mean an uptick in economic activity. And that means the perceived tailwind of lower gas at the pump (which was never realized by most U.S. retailers) could very quickly become a headwind.
It’s my view that U.S. retailers are a short at current levels, and the chart of the XRT, the S&P Retail etf, looks downright horrible. The 2 year chart below shows the sharp downtrend the etf has been in since July, the recent bounce off of a short term double bottom and the etf now bumping up against the downtrend:
More distressing is the 8 year chart showing the recent break below the uptrend that has been in place since its lows in 2008 during the financial crisis. A rejection here at the downtrend from the 2015 highs could mean a test of the recent lows at $38 and possibly a move to the mid to low $30s as there is an air-pocket below:
Short dated options prices have been in a steady uptrend since last Summer, with 30 day at the money implied volatility at 26.6% (blue below, the price of options) but have recently come off of multi-year highs and are approaching that uptrend. What’s interesting is that realized volatility (how much the etf has been moving, white below) is above that of implied at 28.7%. This suggests to me that in the near term, given the plethora of retail earnings upcoming, that option prices could be cheap:
So what’s the trade?
*XRT ($41.30) Buy the March 41 puts for 1.15
Break-evens on March expiration:
Profits: below $39.85
Losses: of up to 1.15 above $39.85 with total loss of 1.15 above $41
Rationale – A slew of earnings are on deck for components of XRT. From a technical perspective, bad earnings and guidance in the group means XRT likely fails at this downtrend and revisits recent lows if not worse. We’d look to spread this put on a move lower, perhaps by selling the 36 put if it became a little meatier, but it doesn;t seem worth it to spread until we saw a move lower. On the upside we’d look to cut our losses at about half of the value of the put if the XRT was able to break through the resistance to the upside.