Jon Lewis

How to Play Retail

by Jon Lewis   11/11/08

Free Trading Guides

With the crumbling of the retail sector hitting the news recently in the form of same-store sales results, don't think the worst is over.

The holiday season is upon us, and I haven't heard anyone say that sales will even be "OK." The fact that everyone is assuming the future will be miserable should mitigate future price declines. Note the word "mitigate," not "avoid."

The other shoe will drop as several major retailers -- including Wal-Mart (WMT), J.C. Penney (JCP), Nordstrom (JWN), Macy's (M) and Kohl's (KSS), among others -- step into the earnings confessional. Results are expected to be miserable, except for Wal-Mart (WMT).

So how do you play a decline in retail?

The obvious answer is the Retail HOLDRs (RTH), which is actively traded and has very liquid options. But be careful, because RTH is not all that it appears. Actually, maybe it's more than it appears. Let me explain.

The Retail HOLDRs is heavily weighted with WMT -- 27% to be exact. That means WMT has a heavy influence on RTH's performance. Home Depot (HD) is second at just under 12%.

WMT is up 12.5% this year, which is hardly reflective of overall sector performance. Home Depot is down 22%, which, believe it or not, is better than the overall market. So nearly 40% of RTH is represented by two outperforming companies.

The bottom line is that RTH has outperformed other retail indices. RTH is down 23% for the year. The S&P Retail Index (RLX) is down 33%. WMT makes up just 2.6% of RLX. HD isn't even in the RLX.

Hmmm, you think there's a relationship here?



If you want to play the downside on retail using ETFs, consider the S&P Retail SPDR (XRT), which reflects the performance of the RLX. WMT isn't even among its top 10 holdings.

The ETF has severely underperformed RTH for the past year (see chart below), and it has liquid options. Check it out if you want to take advantage of retailers' collective misery.



UNUSUAL OPTION ACTIVITY

In addition to our take on the retail sector, as usual, we're providing a list of recent unusual put and call activity in the tables below.

A stock on the call/put list that is showing signs of technical weakness (trading lower and below key trend lines, such as its 50-day moving average) and is fundamentally weak (e.g., poor earnings growth) is a potential short-side candidate.

In contrast, a stock on the put/call list that is showing signs of technical strength (trading higher and above its 50-day) and is fundamentally sound is a potential buy.

Companies that are only on one list or the other are bolded in the tables below.

Unusually High Call Activity (High Call/Put Ratio)



Unusually High Put Activity (High Put/Call Ratio)



There's plenty of money to be made in the retail sectors -- just avoid the hype and look for options to point you toward the less obvious possibilities.