Playing Wal-Mart (WMT) With Options

The Financial Times reported today that Wal-Mart (WMT) will be cutting costs by merging its purchasing for several countries, which should reduce costs by 5% to 15% across the supply chain within five years. This cost reduction to 15% would equal savings of roughly $4 billion to $12 billion for the world’s largest retailer, that is if WMT meet its long-term goal of shifting to sourcing about 80% of purchases directly (the report cited Vice Chairman of Wal-Mart Stores Inc, Wright Eduardo Castro).

Coincidentally, Mr. Castro sold 17,000 shares of his WMT shares on Dec. 29 at an average price of $54.06 a share and another 42,071 shares back on Dec. 14 at the average price of $53.92.

While it is certainly more comforting to have the executives buying shares if you plan to invest in a company, remember there are many reasons why a director may sell or buy shares, which may be more personal than corporate. Stock repurchase plans initiated by a company itself are generally a positive sign, but certainly not a guarantee of success.

With WMT, its stock price has been fairly flat on the year. While this may not be exciting, the price movements in WMT over the last year were much more tolerable than the rest of the equity markets, not to mention could make WMT the perfect covered call candidate.

As discussed before, the covered call is almost identical in risk and usage as the short put, however, timing the entry and exit of each strategy are slightly different. Typically, traders who sell covered calls against long stock do so at different times. In WMT for example, a trader who bought on Dec. 18 at $52.50 might be looking to sell their covered call (possibly the February 55 call for 90 cents) on a day like today when the stock is rallying. The covered call trader would like to acquire their stock as a cheaper price, possibly on a day when the stock is down, which was the case on Dec. 18 and then let the stock rally until selling the short call in the front month against the long stock position (remember you sell one call for every 100 shares owned). The short call is typically sold at or out of the money, which means the call strike is at or above the stock price.

This technique allows the trader to not only lower his cost basis in the stock, but also increase the premium collected in the call that is sold being that call prices rise when stocks rise. Once the trade has been made, the ultimate goal is to have the stock finish right at the short call strike.

The short put is just a single trade, which does not require the purchase or sale of stock. In WMT, if a trader were to employ a short put, typically the best entry would be on a day when the stock is selling off. Remember that the put is the polar opposite of the call and put prices increase as stocks fall. Because the short put is a single leg trade, it might be a bit easier to time, but again this depends on the trader. The different with the short put is that it obligates you to buy 100 shares at the strike price you sold minus the credit you received. With WMT, today would most likely not be the best entry point for a short put, but again it depends on your view on the future of the stock. If you believe that WMT will rise from this level and at least stay above $52.50 for the next month and a half, the February 52.50 put can be sold for 77 cents. This essentially means that you are OK with possibly owning WMT at $52.50 – 77 cents, or $51.73 per share. WMT has not traded at $51.73, since Nov. 9, 2008. WMT does have a 31-cent quarterly dividend, which you do not receive if you are short the put. But both the put prices and call prices are adjusted to account for this dividend. In other words, calls are cheaper and puts more expensive by the amount of the dividend if there is one or more within their expiration.

Regardless of what strategy you choose, both the covered call and short put offer potential strategies that investors can employ on a moderately bullish WMT.