What’s In Store for Box Stores? – XRT

by riskreversal September 29, 2016 1:40 pm • Trade Ideas

Earlier today I had some thoughts on Costco (COST) into tonight’s earnings results (MorningWord 9/29/16: COST’$ Cut).  The crux of it is becoming painfully obvious, Amazon.com (AMZN) is eating brick and mortar retail’s lunch quarter by quarter and making rapid inroads into once defensible models, like Costco membership.

In the last two months we’ve seen disappointing earnings results/guidance given by the likes of Lowe’s, Nike, TJ Maxx, Target and of course Costco. The disappointments have ranged from the high-end to the low-end, while AMZN saw sales grow 22% year over year, sporting their highest North American retail margin ever.  To put AMZN’s dominance in some sort of context, the stock’s $390 billion market cap is greater than WMT, TGT and COST, three companies with combined 2016 sales of $680 billion, 5x that of AMZN’s expected $137 billion. Yeah I know this is where you say but, but AWS, and I”d just add that despite its rapid growth (expected to be $10bn in 2016 up from $7bn in 2015), margins have plateaued and likely to be under at least slight pressure as Google, Microsoft & IBM step up competition, still does not account for the lion-share of the nearly $400 billion market value.  As long as AMZN can use AWS profitability to expand Prime, and subsidize retail, traditional retail will remain challenged as they have to continue to spend (see WMT’s $3.3bn bid for Jet.com) in the real world to fend off the existential threat that is AMZN.

Which leads me to my bearish view on retail as a whole.  I don’t think it makes a ton of sense to press shorts in COST, LOW, TGT and TJX, but taking a view on the sector itself could make sense. I’ll add one more point, if Apple (AAPL) is truly set to release magnificent results for the iPhone 7, and offer guidance that suggests the upgrade cycle for the phone should carry through year end, than this could also be a drag on other discretionary retail.

The S&P Retail etf, the XRT, which is fairly equal weighted among dozens of stocks looks fairly vulnerable from a technical perspective, just below its 200 day moving average (yellow below), and approaching the uptrend that has been in place from its 2016 lows made in February:

[caption id="attachment_66718" align="aligncenter" width="620"]xrt1yr29 XRT 1yr chart from Bloomberg[/caption]

Taking a look from the 2008 lows, the etf was just rejected at the long term uptrend that should serve as meaningful technical resistance, with little near term support till $40:

[caption id="attachment_66719" align="aligncenter" width="637"]sg2016092947433 XRT since 2009 from Bloomberg[/caption]

And here’s the 5 year chart which highlights what could be a massive head and shoulders top:

[caption id="attachment_66725" align="aligncenter" width="600"]XRT 5yr chart from Bloomberg XRT 5yr chart from Bloomberg[/caption]


So what’s the trade?

*XRT ($43.15) Buy Jan 43/37.50 put spread for $1.35
  • Buy 1 Jan 43 put for 1.80
  • Sell Jan 37.50 put at 45 cents

Break-even on Jan expiration:

Losses of up to 1.35 above 41.65 with total loss above 43

Gains of up to 4.15 below 41.65 with max gain of 4.15 at or below 37.50

Rationale – This trade plays for a break below recent support with nice risk reward for a move back to 2016 lows in the etf into the beginning of 2017.  The trade targets a move back to the neck-line of what could be a head and shoulders top formation back near $37.50.