Retail juggernaut Wal-Mart (WMT) will be reporting third-quarter results later this week and Wall Street will be paying close attention.
With so much concern over the state of the economy and the upcoming “fiscal cliff,” Wal-Mart earnings will be used as a barometer of how positive consumer sentiment really is. In addition to its recent quarterly results, much attention will be paid to the company’s forward guidance.
When Macy’s (M) reported its results last week, it raised its full-year guidance, signaling that consumers are ready to spend and that hurricane Sandy will not have as big of an impact on retailers as some had feared.
If Wal-Mart is able to produce the type of earnings and forecast we saw from Macy’s, it will go a long way toward boosting investor confidence in the retail sector.
So how can we play the upcoming earnings from Wal-Mart?
Wal-Mart current price = $72.25
1. Long the Stock
risk level = moderate
If you believe that we are going to see strong results from Wal-Mart, the easiest way to take advantage of the gain we will see following the report is to go long the stock. The stock is up slightly more than 23% so far this year, so there is the danger that the stock is already losing its value, but with a P/E of just 15, we believe that there is still room to the upside. We like the stock at its current price, but would not want to hold onto any shares if we see the P/E start to climb over the 20 mark.
2. Bull-Put Credit Spread
risk level = low
A great way for investors who are a little worried about the recent strength in the stock is to get in with a hedged play. A bull-put credit spread is the perfect way to get into the stock, while still allowing a little downside protection in case the stock turns against us. You could set up a January 67.50/62.50 credit spread for a credit of 45 cents. In this trade you will be selling January 67.50 puts while buying the same number of January 62.50 puts. This trade would give you a target return of 8.1%, and offers you 6.5% of downside protection in case the stock trades lower.
3. Buy Calls on the Stock
risk level = high
This option is for very bullish investors, since the risk is much greater. With the stock already trading up 23% this year, we would probably be a bit weary of buying calls, but if the company does put up blow-out numbers and boost its full year guidance, the stock should trade up a few percentage points at the least. You can take a look at the January 77.50 calls, which are currently trading at $0.30 per contract. Should the company post strong earnings, and the stock starts to move higher, so will this option. You do not need to hold onto to the option through January expiration, we would expect to see the options trade higher immediately following an upbeat report, and you should be able to lock in some profits rather quickly. If the stock does jump and you can lock in gains quickly following the report we would do that, and not risk holding these options through Black Friday weekend, when any negative reports on customer turnout would negatively impact the stock.
4. Buy Puts on the Stock
risk level = high
Given the strength we have seen so far this year, you may be bearish on the stock. This is reasonable, and if you want to play your bearish sentiment you may want to consider buying some puts on WMT. Due to the high level of risk that comes along with naked option buying, this is an approach you should only take if you have a high degree of faith in a disappointing earnings report. If you believe Wall Street is going to be disappointed with Wal-Mart’s earnings, you could look at the December 72.50 puts, which are currently trading at $2.10 a contract. Because the stock has traded up so much so far this year, it has a long way to fall in the event of an earnings miss, and these options should move quickly. If we see an earnings miss, and a quick drop in the stock as a result, we would try to take our gains on these options, and not look to hold onto the contracts through expiration.
Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va. His articles typically cover big-picture events and forecasting what impact they will have on the stock market. In addition to writing for Fresh Brewed Media, Michael also wrote for AOL's BloggingStocks for three years, focusing most of his attention on the energy and technology sectors.