Options Corner: Fading Consumer Spending Warrants Cautious Take On Shopify

Under normal circumstances, e-commerce platform Shopify Inc. SHOP would probably be a decisively net bullish idea. Fundamentally, the company has become one of the top avenues for retail transactions, particularly among younger customers. Unfortunately, consumer spending faces significant challenges in the form of inflation and the trade war. With these realities in mind, investors may want to rethink the upside narrative of SHOP stock.

Primarily, one of the biggest (if not the biggest) headwind slamming against Shopify is the erosion of consumer spending. After nearly a two-year period, the U.S. economy posted a contraction in the consumer spending rate for the first time. Inherently, this datapoint impacts the cyclical retail sector, which in turn clouds Shopify's core business.

Investors seeking relief have realized that they probably can't rely on the Trump administration, at least for near-term solutions. Earlier on Tuesday, President Donald Trump announced plans to impose an additional 25% tariff on steel and aluminum imports from Canada, driving up the total levy to 50%.

It's not so much that the tariffs directly impact SHOP stock. Rather, it's that the White House appears willing to engage in an economic stare down, irrespective of certain consequences.

Nevertheless, not everything centers on the tariffs. Households who have been struggling with high grocery bills can point the finger to a bird flu outbreak, extreme weather events and labor shortages. With these headwinds, some experts believe food prices will continue rising. If so, this dynamic will likely crimp discretionary spending further, thus weighing on SHOP stock.

Dip-Buying Sentiment Has Its Limits for SHOP Stock

Despite the troubles impacting Shopify's revenue streams, the market's discount certainly appears tempting. On a year-to-date basis, SHOP stock is down about 13.5%. In the trailing month, it has slipped roughly 26%. Nevertheless, investors historically have had a nuanced approach to dip-buying sentiments.

As a baseline, it's fair to say that SHOP stock enjoys an upward bias. Using pricing data since January 2019, any given eight-week long position has a 58.86% chance of being profitable. During this period, the median positive return clocks in at 20.22% while the median negative return lands at 10.79%. Assuming a starting price of $92, the projected range over eight weeks would be $82.08 to around $110.61.

When SHOP stock incurs sizable volatility up to 10% over a one-week period, there is evidence that investors buy such dips. Combined with the fundamentals of a normal economic cycle — that is, without trade wars, rising food inflation and other negative catalysts — SHOP would likely be a strong bullish candidate.

That's not what's happening here. Last week, SHOP stock lost 11.3% of equity value. Under this dynamic condition where SHOP loses between 10% and 20% in a one-week period, the risk-reward worsens considerably.

Over an eight-week period, the chances of a long position being profitable following the aforementioned extreme-fear event is only 35.29%. Interestingly, the median positive return during this period is similar to the baseline at 25.72%. However, the median negative return falls to 23.8%.

In other words, from a statistical standpoint, uncertainty rises following extreme volatility, expanding the range of likely price outcomes. In addition, it's far less probable for the bulls to win out in the near term.

Two Trades on Tap for Shopify

Understanding the possibility of both an expanded price range and bearish activity, traders have two main approaches available with SHOP stock. First, they can buy a long iron condor, which anticipates rising volatility over time.

Specifically, the most aggressive long iron condor is the 75P | 80P || 95C | 100C — or the combination of the 70/75 bear put spread and 95/100 bull call spread — for the options chain expiring April 17. Based on similar circumstances, SHOP stock could drop to either $72.47 or rise to $101.18, enough to trigger either short strike price ($75 or $100) at expiration. This would allow the speculator to collect the maximum reward.

However, one of the long iron condor's disadvantages is the expense: the trader is paying for two premiums. Instead, the most aggressive traders could choose to go directional with just a bear put spread.

For the same April 17 expiration date, a tempting trade would be the 90/85 bear put spread. This transaction involves buying the $90 put (at a $615 ask) and simultaneously selling the $85 put (at a $400 bid).

The proceeds from the short put partially offsets the debit paid for the long put, resulting in a cash outlay of $215. Should SHOP stock fall to or below the $85 short put strike at expiration, the trader can collect the maximum reward of $285, or a payout of about 132.6%.

Photo: Shutterstock