Two Trading Strategies in Wal-Mart Stores (WMT)

Wal-Mart option strategies Watch for falling stock prices? Goldman Sachs recently expressed bearish sentiment on Wal-Mart Stores WMT, downgrading shares of the retailer to neutral from buy. Reasons for the downgrade included inflationary risks in the food and apparel sectors, which could limit margin upside. Goldman analysts also opined that the sheer size of WMT limits growth potential for same-store sales.

Going back to the late 90s, WMT has been the epitome of a range-bound stock, spending nearly all of its time bouncing between 40 and 60. The stock is now trading near the upper end of this long-term range. What's more, the stock is within a dollar of its 52-week high of $56.27.

Simply buying or selling range-bound stocks may not be the quickest way to profitability; if the stock doesn't move, portfolios don't either. There are, however, options strategies designed for low-volatility stocks and indices. To learn more about the pros and cons of these neutral trading strategies, join Bill Sullivan and me for our free Two Traders, One Strategy series Tuesdays after the close. Next Tuesday's webinar strategy? Iron condors.

Two strategies on Wal-Mart (one for bears, one for bulls) are for educational purposes only and are not buy/hold/sell recommendations. Prices were taken Thursday morning, when WMT shares were trading at $55.22, up 37 cents on the day.

Bearish Option Strategy: Ratio Put Spread

Here's a strategy for those who side with Goldman and think Wal-Mart may have trouble growing from its current levels. A ratio put spread (also known as a put one-by-two) is built by shorting two out-of-the-money 50 puts and going long one near-the-money 55 put. This trade is currently priced for 75 cents.

At expiration, if WMT is trading right at the short strikes (50), the maximum potential profit is $4.25, or the difference in put strikes minus the debit paid. Breakeven to the downside is $45.75, or the short strike less the maximum profit. Breakeven to the upside is $54.25, or the long strike less the premium paid. If WMT is trading between these levels when the options expire, the spread will be profitable.

This trade provides a limited downside hedge of roughly 17% to the downside breakeven. Below this, however, downside risk is more substantial because of the additional uncovered short put that is in-the-money below 50 dollars. If WMT moves sharply lower, losses are in line with a long stock position. To the upside, losses are limited north of the 55 strike to the 75-cent debit paid.

Charts built with the OptionsHouse profit/loss calculator.

Bullish Option Strategy: Buy-Write

Traders on the optimistic side of the street could consider buying WMT shares and selling the March 55 calls. This is known as a covered call or a “buy write” when the trades are done simultaneously. The premium collected for selling the call is currently $1.43. Because this call is slightly in the money, 22 cents of this premium is intrinsic value.

Add in Wal-Mart's quarterly dividend of 32.25 cents per share, and the potential yield for this trade is 16.25% annualized assuming you are called away (which is roughly 50/50 given that the call is at-the-money). The caveat to this would be if investors are called away early (obligated to deliver WMT shares to the call buyer) before the stock's ex-dividend date on 3/9/11.

Not including the dividend factor, the maximum potential profit at expiration for the covered call is $1.21, or the difference between the call premium collected ($1.43) and the amount by which the call is in-the-money (22 cents). Breakeven is $53.79, or the stock price at the time of purchase plus the maximum potential profit.

If the short call is not exercised, there is downside exposure to the zero mark because of the long stock position. Even this downside is partially offset, however, by the initial credit collected from selling the call.

Profit and loss of Wal-Mart (WMT) covered call

Photo Credit: Monochrome

The above information is provided by OptionsHouse, LLC (“OptionsHouse”) for informational and educational purposes only and is not intended as trading or investment advice or a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. You are solely responsible for your investment decisions. Commentary and opinions expressed are those of the author/speaker and not necessarily of OptionsHouse. Neither OptionsHouse nor any of its employees, officers, shareholders or affiliated companies guarantee the accuracy of or endorse the views or opinions of guest speakers or commentators. Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature and are not guarantees of future results. Any examples used that discuss trading profits or losses may not take into account trading commissions or fees.

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