Wednesday, July 11, 2012

WMT: Breakout from a 13-year sideways trend

Wal-Mart Stores Inc. (WMT) is the world's largest retailer by revenue (and third largest corporation in any sector). The Bentonville, Arkansas company's closest competitor for size, the French "hypermarket" Carrefour, only ranks 21st on the big companies list.

The Walmart stores, for many Americans, are an essential landmark in their lives: From the goodies for the Walmart baby registry to clothes, groceries and portable air conditioners for the summer heat wave, Walmart comes through for its shoppers with little style but at very low prices.

WMT is one of the few big companies that can be reasonably traded at this point without colliding with earnings. One of my rules is to avoid opening positions in stocks within a month of earnings, although I will hold existing positions through earnings. 

As a corollary, I avoid entering a position that must be closed just after an earnings announcement, when a price gap can be devastating.

WMT, which announces earnings before the open on Aug. 16, meets my criteria for a short-term play using August options, which expire Aug. 17. I would need to design the position so that it would be closed by Aug. 15 at the latest (and most likely I would close on Aug. 12 or 13.)

One trading consideration is an Aug. 8 ex-dividend date for a quarterly payout yielding 2.21% annualized. That will inevitably cause the price to drop slightly to account for the 40-cent dividend -- nothing massive but still worth avoiding.

The retailer's price has been in a consistent uptrend since May 17, when it gapped sharply upward from $59.35 after a 5% earnings surprise. the price hit an all-time high of $72.58 on Tuesday but is down intra-day today, while remaining within Tuesday's range.

Very long term, WMT has been in a sideways trend since 1999, ranging from around $43 to $63, with numerous breakouts and breakdowns that were quickly corrected. This breakout is significant because it is the only one to exceed the pre-sideways-trend peak of $70.25 that culminated the stock's three-year rise from $9.55.

That level of breakout is no guarantee against a retracement, of course. It does show significant momentum. Volume has been running a few percentage points above levels recorded before the recent uptrend began.

Nor is it a guarantee that the trend will continue. The price has gained 22% since May. Surely most of the money that will be piling into WMT has already piled in.

And frankly, analysts are underwhelmed by the rise. The 22 following WMT show an enthusiasm index of negative 9%, the same as a month ago in the midst of the uptrend and two months ago around the time it began.

Wal-Mart reports return on equity of 24% with a somewhat high level of long-term debt, amounting to 79% of equity.

Annual earnings have risen consistently thought the recession (a pretty good trick for a retailer), although the pace of increase slowed dramatically in the fiscal year ending Jan. 31.

Wal-Mart followed the typical retailer pattern of peak earnings in the 4th quarter. That quarter's earnings have risen consistently for two years, although the most recent had a small downside earnings surprise.

Of the past 11 quarters, nine showed surprises to the upside and two to the downside.

Institutions own 30% of shares -- quite low for a giant company -- and the price is very cheap; it takes just 54 cents in shares to control a dollar in sales.

WMT on average trades 10.5 million shares a day, but even so it has only a moderate selection of option strike prices. Yet the open interest is high and the bid/ask spreads are narrow. The strike selection is adequate for most normal option strategies.

Implied volatility stands at 19%, slightly above the middle of the six-month range. The volatility trend has been sideways since late June.

Options are pricing in confidence that 68.2% of trades over the next month will fall between $67.98 and $75.79, for a maximum 5% gain or loss.

The pace of options trading is about on a par with the average volume of the past five days, with puts slightly more active than calls.

The stock is trading in the upper portion of the five-day fair-price zone, which runs from $70.31 to $72.06 and contains 68.2% of trades. The most traded price is $71.16, although a new, higher most-traded is in the process of being established around $72.01.

As noted above in my timing discussion, Wal-Mart next publishes earnings on Aug. 16. The stock goes ex-dividend on Aug. 8 for a quarterly payout yielding 2.21%.

Decision for my account: I like the chart and the financials. My challenge with WMT is to construct a position that will give some cushion if the price retraces, as seems probable, in the wake of this rapid run-up, while retaining the ability to profit if the price keeps rising.

That means I need a position that gives some up-front return.

One way to play it would be as a covered call, with the premium from sale of the August $72.50 call plus the dividend payment amounting to a 2% gain. The stock can be retained as a basis for future covered call spreads.

Another possibility is a diagonal call, based on a long December $67.50 call option while selling the August $72.50. There's no dividend gain under this strategy, but the premium from the sale of the call amounts to 20%. And there are three more opportunities to sell calls against the the December option.

And of course there's always the short-term, keep-it-simple bull put spread: Sell the August $70 put and buy the August $67.50 put for a potential 28% profit on risk and a guarantee that the position ends in August. This is the only net credit position among the three. The others cost money.

The bull put spread is profitable at expiration down to about $69.45. The theoretical price hit from the dividend is 40 cents, which would cut the current price from $71.88 down to $71.48. Since maximum profit is good down to about $70, then the dividend has no impact on this position (all else being unchanged from where they stand today, a fairly silly assumption).

And I've decided on the the bull put spread position as described above. Just opened it, for a 53 cent credit per contract.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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