Option Strategies for Range-Bound Wal-Mart (WMT)

Wal-Mart WMT may still encourage its customers to “watch for falling prices,” but they may be harder to find these days. A recent anecdotal study from J.P. Morgan Securities revealed that Wal-Mart has upped the average prices at its stores by about 6% during the past month. Rising fuel costs and a lift in the price of raw materials have necessitated this change, according to analysts.

In other news, Sam’s Club, the club-style chain under WMT’s umbrella, plans to offer free Wi-Fi to its shoppers. The goal is to provide resources for customers to compare prices on their smartphones while they are still browsing in the store.

New developments at Wal-Mart could draw some attention to shares of the retail giant, which have been in a directionless funk for more than a decade. Since late 1999, the stock has made few trips below 45 and has spent limited time above the 60 mark. In recent years, that sideways range has contracted, defined by 45 to the downside and 55 to the upside.

For a range-bound stock like this, there are few opportunities for stock traders, unless they correctly forecast a short-term pullback or rally. Option strategies, however, can come in handy on stocks with a neutral outlook.

We’ve outlined two potential option strategies here – a risk reversal and a long call butterfly. Remember these are not buy/sell/hold recommendations, merely examples of various strategies for educational purposes. The prices are taken as of Tuesday’s close, when WMT shares were trading at $52.22, up 16 cents on the day.

Bullish Option Strategy: Synthetic Long Stock (Split Strike)

A tight risk reversal (also known as a split strike synthetic long stock) could work for bullish investors who believe the downside is limited while the upside might prove compelling. This strategy utilizes options to simulate long exposure to the stock price, requiring less capital at the outset. By buying the September 52.50 call and selling the September 50 put, an investor pays a net debit of 32 cents per spread. If WMT is between the two strikes when the options expire, the loss is capped at this 32-cent premium.

As the stock moves higher above the breakeven price of $52.82 (the call strike plus the debit paid), the position begins to gain in value, and the potential reward is unlimited. On the flip side, the synthetic long stock is a loser below $52.82, and losses can be as much as $52.82 if WMT were to fall all the way to zero.

Wal-Mart (WMT) synthetic long stock

Neutral Option Strategy: Long Call Butterfly

Traders who expect WMT to hover close to its current level through the next several weeks could look at a September-dated long call butterfly. The September 50/52.50/55 call butterfly can be purchased for a net debit of 96 cents by simultaneously executing the following:

Buy one September 50 call
Short two September 52.50 calls
Buy one September 55 call

If WMT shares are trading right at the sold strike ($52.50) when these options expire on September 17, the trader collects the maximum potential profit, which is $1.54, or the difference between the short and long strikes minus the premium paid. Losses are limited to the premium paid ($0.96) and occur if WMT shares are trading below $50 or above $55 when the calls expire. This is a potential return on risk of 160% in fewer than six weeks.

The downside breakeven for this strategy is $50.96 (the lower-strike long call plus the premium paid) while the upside breakeven is $54.04 (the higher-strike long call minus the premium). At expiration, if WMT shares are trading anywhere between these levels, the butterfly spread will be profitable (before commissions).

Wal-Mart (WMT) long call butterfly