How to Trade Retail Stocks Before Black Friday – Barron’s

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Shoppers at a Best Buy in San Francisco, Calif., last November. Bloomberg News

With Black Friday post-Thanksgiving sales fast approaching, and Christmas just beyond that, trading opportunities are emerging in the retail sector.

Strategists are increasingly telling clients to buy relatively inexpensive puts and calls to wager that holiday sales will drive sharp stock moves in many retail stocks.

While many investors loathe retail stocks – not without justification — and generally fear holiday sales will be weak amid fears of slowing global economic growth, the sector’s options dynamics are attractive.

Retail sector options prices are widely muted, enabling investors to trade without paying big fear or greed premiums. This dynamic may change as investors start focusing on holiday sales data.

Bernard Sosnick, the dean of Wall Street’s retail sector analysts, is telling clients that the timing is ripe to trade the sector.

“It would seem that this is the time to begin accumulating retail stocks, especially since lower gasoline prices and improved employment enhances the spending power of consumers, particularly those with low incomes,” Sosnick, now with Madison Global Partners, recently advised clients.

To be sure, as he notes, there are also reasons to remain cautious, including increasingly virulent competition from traditional stores and online retailers, led by Amazon.com (ticker: AMZN AMZN 2.510492771646199% Amazon.com Inc. U.S.: Nasdaq USD659.45 16.15 2.510492771646199% /Date(1447877668577-0600)/ Volume (Delayed 15m) : 2592808 P/E Ratio 952 Market Cap 301554584637.305 Dividend Yield N/A Rev. per Employee 652745 More quote details and news » AMZN in Your Value Your Change Short position ). Department stores, in particular, have been hammered as Macy’s, Dillard’s, Nordstrom and others disappointed investors with their earnings reports.

So far in November, retail stocks have underperformed the Standard & Poor’s 500 Index by a whopping 7%, according to Goldman Sachs. The bank’s derivatives strategists are telling clients to “straddle” many key retail stocks.

The straddle strategy — buying puts and calls with strike prices that match stock prices — expresses a view that options prices are too low ahead of market-moving events. The strategy pays off if stocks rise or fall.

Goldman’s key trades include:
• Buying Ralph Lauren’s ( RL RL -0.4085652028159571% Ralph Lauren Corp. Cl A U.S.: NYSE USD118.8325 -0.4875 -0.4085652028159571% /Date(1447877666665-0600)/ Volume (Delayed 15m) : 590786 P/E Ratio 18.498371183191235 Market Cap 10105720953.7011 Dividend Yield 1.6852039096730704% Rev. per Employee 300240 More quote details and news » RL in Your Value Your Change Short position ) January $120 straddle for $12.60 when the stock was at $119.32.

• Buying Macy’s ( M) M 2.394162503286879% Macy’s Inc. U.S.: NYSE USD38.9405 0.9105 2.394162503286879% /Date(1447877667429-0600)/ Volume (Delayed 15m) : 6447569 P/E Ratio 10.162303664921465 Market Cap 11956631384.0942 Dividend Yield 3.7094281298299845% Rev. per Employee 165213 More quote details and news » M in Your Value Your Change Short position December $37.50 straddle for $3.46 when the stock was at $38.03.

• Buying Kohl’s ( KSS KSS 1.2059023836549376% Kohl’s Corp. U.S.: NYSE USD44.5812 0.5312 1.2059023836549376% /Date(1447877660910-0600)/ Volume (Delayed 15m) : 2031497 P/E Ratio 11.838543053410724 Market Cap 8567636800.00458 Dividend Yield 4.048291620935965% Rev. per Employee 139810 More quote details and news » KSS in Your Value Your Change Short position ) December $45 straddle for $3.95 when the stock was at $44.05.

• Buying Nordstrom’s ( JWN JWN 1.8210102489019033% Nordstrom Inc. U.S.: NYSE USD55.635 0.995 1.8210102489019033% /Date(1447877668029-0600)/ Volume (Delayed 15m) : 1677691 P/E Ratio 15.840974212034384 Market Cap 10130255553.3447 Dividend Yield 2.6770371710228815% Rev. per Employee 213239 More quote details and news » JWN in Your Value Your Change Short position ) January $55 straddle for $5.25 when the stock was at $54.64.

For straddles to prove profitable, the stock must move more than the cost of the options trade. What would cause such sharp moves? Holiday sales that are better or worse than expected.

Of course, there are other ways to trade retail stocks.

Susquehanna Financial Group is telling clients that Dick’s Sporting Goods ( DKS DKS 1.1634199134199135% Dick’s Sporting Goods Inc. U.S.: NYSE USD37.39 0.43 1.1634199134199135% /Date(1447877668530-0600)/ Volume (Delayed 15m) : 4689482 P/E Ratio 12.30232558139535 Market Cap 4382194480.48759 Dividend Yield 1.4852822036186875% Rev. per Employee 191248 More quote details and news » DKS in Your Value Your Change Short position ) sold off too much after disappointing Wall Street. The stock lost about 9% of its value Tuesday after reporting disappointing earnings. Dick’s bearish put options prices are now trading around two-year highs.

Chris Jacobson, a Susquehanna strategist, is telling clients the decline represents an opportunity to buy a category leader at an attractive stock price by using an options strategy that takes advantage of investor fear.

Jacobson is telling clients to sell Dick’s March $33 put and buy the March $44 call. The trade cost 30 cents when the stock was at $36.96.

The risk reversal — selling a put and buying a call with different strike prices but identical expirations — obligates investors to buy the stock if it falls below the $33 strike price. If the stock is above $40, the call increases in value. At $45, the call is worth $5.

We usually never recommend investors trade options just for the sake of attractive pricing dynamics, but the retail sector, now largely unloved and unwanted, is too tempting on the cusp of a big event.

STEVEN SEARS is the author of The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.
Comments: steve.sears@barrons.com, http://twitter.com/sm_sears