Daily Gains Letter

Darker Clouds Ahead for Retail Space…But Not for Retail Investors

By for Daily Gains Letter |

Muted Retail SectorThis past week, as many of my readers may recall, I discussed the slowing that’s occurring in the global economy as demonstrated by consumer spending at both McDonalds Corporation (NYSE/MCD) and Wal-Mart Stores Inc. (NYSE/WMT).

Now, my concerns have just picked up following Wednesday’s retail sales reading. The core reading excluding automotive and food sales grew a mere 0.1% in July, according to the U.S. Department of Commerce, which was below the 0.3% estimate and the weakest reading since way back in January, when Old Man Winter was blamed for everything.

But with the winter excuses over, it still appears consumers are hesitant on wanting to spend. Not only is consumer spending on everyday items drying up, but spending on durable goods, such as furniture, appliances, and electronics, is curtailing.

Department store operator Macy’s, Inc. (NYSE/M) reported a mere 3.3% year-over-year increase in its second-quarter sales. The company’s key comparable store sales managed to rise 3.4% in the second quarter, but things are looking somewhat soft for the whole of 2014, with Macy’s estimating growth in comparable store sales of only 1.5%–2.0%, versus its previous 2.5%–3.0% estimate.

These numbers, along with those from the discounters and big-box stores, show some darker clouds on the horizon for the retail sector, as retailers across the board try to keep afloat.

I don’t expect a sell-off in retail, but the upside looks to be limited for the foreseeable future, as the economy and jobs look to sort things out.

Take a look at the SPDR S&P Retail ETF (NYSEArca/XRT), which reflects the current sideways moves in the retail sector, with this exchange-traded fund (ETF) hovering aimlessly around its 50-day and 200-day moving averages (MAs). The relative strength index and MACD (moving average convergence/divergence) are also neutral, based on my technical analysis.

SPDR S&P Retail Index Chart

Chart courtesy of www.StockCharts.com

Given the near-term uncertainties, what investors need to do is look at buying the key retail stocks on weakness.

However, another trading strategy would be to play a potential move in the SPDR S&P Retail ETF to the upside or downside. This can be done via the formation of a neutral long straddle option trade on the SPDR S&P Retail ETF. The option trade will pan out as long as there’s a relatively strong move, either upward or downward, in the SPDR S&P Retail ETF options and it’s enough to cover the premium paid. Of course, the move must be before the option expiry.

The option straddle involves the buying of a call option and put option with identical strike prices and expiries. The trade works if the SPDR S&P Retail ETF moves largely either upward or downward from the strike price.

One thing investors need to remember, though, is that picking the right expiry is key. For the SPDR S&P Retail ETF, option expiries are September and December 2014, along with January and March 2015, and January 2016.

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