Option Strategies for Range-Bound Wal-Mart Stores (NYSE:WMT)

Wal-Mart's WMT plan for world domination has extended to the Cape of Good Hope. The world's largest retailer has announced its intention to spend nearly $4.8 billion on the South African chain of Massmart low-cost retail stores. The Congress of South African Trade Unions (Cosatu) quickly voiced its displeasure, noting they will “oppose the setting up of any [Wal-Mart] stores in [the area].”

It's the never-ending debate … Wal-Mart argues that its low prices save the community money. Opponents argue that the retailer treats its employees unfairly by not allowing unionization (among other complaints).

This type of drama notwithstanding, WMT is a rather boring, range-bound stock. Since the end of the 90s, WMT shares have been chugging along sideways between 45 and 60, with very few visits outside of this range.

Over the last few months, the stock has been moving higher after briefly dropping below the 50 level in July. Investors who feel WMT could move back toward the upper end of its historical range may consider bullish option strategies that have higher profit potential than the stock outright. Others may think an 8% jump in three months is too much for WMT to handle and may be taking a more cautious stance.

For the WMT optimists, we've outlined the specifics of a covered strangle strategy below; we've also described a bear put spread strategy for the bears. These strategies are for educational purposes only. All prices are as of Tuesday midday, when WMT shares were trading at $53.22, down 26 cents on the day.

Bullish Option Strategy: Covered Strangle

This strategy combines a long stock with a short strangle for a strategy that will benefit from upside in the shares. The long stock has an annual dividend yield of more than 2.2%. Furthermore, selling the December 50 put and 55 call strangle yields a credit of $1.60, which is almost 3% of the stock price and could be thought of as an income enhancement for this strategy.

The maximum profit, should WMT be trading above $55 at expiration, is $3.38 per strategy. This is the credit collected for shorting the strangle ($1.60) plus the gains in the stock from $53.22 up to $55.00. Gains begin to deteriorate below the $55 strike until breakeven of $51.62. Because this strategy is long stock, the downside breakeven is simply the stock price minus the net credit, or $51.62.

Risk is significant but technically limited as Wal-Mart cannot decline below zero. Below the put strike (50), the position is long 200 deltas so this trade should only be entered into if you are willing to purchase more shares at the short put strike.

This is a rather complex trade. To see what could happen by changing entry prices, strikes, or months, I would encourage using the profit/loss calculator tool in a virtual trading account.

Bearish Option Strategy: Bear Put Spread

Investors who don't believe Wal-Mart has any short-term upside potential could consider a long put spread in the November series. The November 50/55 put spread can be purchased for a net debit of $1.78 per spread (buying the 55 put and selling the 50 put).

The maximum potential loss for the spread buyer is the premium paid, should WMT be trading north of $55 when the options expire. The maximum gain is $3.22, or the different in strikes less the premium. Gains peak if WMT is below $50 at expiration. Finally, breakeven is right at the stock's current price of $53.22. Any move lower in the stock between now and November options expiration will bring the spread into profitable territory (before commissions).

Wal-Mart (WMT) bear put spread profit and loss