Berger On How To Play Wal-Mart With Options

The decline in Wal-Mart’s stock seems to have been triggered by the lowering of the company’s sales guidance for the on-going year, the expectation of foreign exchange rates impacting earnings and the fact that management said that investments of $1 billion in digital initiatives will take a toll on next year's earnings.

“Despite further news of the company investing in digital initiatives and a massive $20 billion stock buyback program investors pounded the stock to levels last seen in the first half of 2012,” Berger explained.

Related Link: Wal-Mart Is Crashing Because It Over-Earned: Here's How To Play The Dip

A Technical Look

On the long-term chart, investors can see that Wal-Mart’s stock fell below its blue horizontal area of support (which had acted as resistance until 2012) Thursday. “With momentum oscillators in record oversold readings this looks to be an overshooting move to the downside that investors could capitalize from by trying the stock from the long side using options,” the expert added.

As a result of the market decline in the stock this week, implied volatility in the options market surged to the 85th percentile of its 52-week range. “This, combined with the increasingly oversold readings on the price charts makes selling out of the money puts or put spreads an attractive strategy for active and strategic investors,” Berger continued.

Investors should also note on the daily chart that “the drop on Wednesday came on a massive spike in volume and also pushed the stock again back to the lower end of its down-trending channel.”

Investors should take into account, however, that by selling naked puts at very oversold readings, “they are essentially saying they feel comfortable being put the stock to (i.e. having to buy the stock) if it falls below the strike price at expiration,” Berger explained. “It can also be looked as another way of buying the stock but getting paid a premium for buying the stock at a lower price.”

According to Berger, the risk/reward profile for investors that believe that shares of Wal-Mart stock will once again rise over the next six months is quite attractive.

The Parameters

Berger shared some parameters for this play:

• Entry: “Sell to open January 55 strike puts for $1 or more in premium. More risk averse investors could also buy a protective January 50 strike put against it.”
• Stop: “Exit the trade if the premium of the January 55 strike put doubles in value, i.e. to $2 or more.”
• Target: “Either let the puts expire worthless and keep the premium or close the position when/if the stock rallies back toward the $70 area.”
• Time Horizon: Three months tops.

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.

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