On Tuesday, Aug. 16, Wal-Mart Stores (WMT) released their earnings for the quarter. Wal-Mart posted a $1.09 EPS for the quarter. This was up from the previous year’s EPS of $0.97, as well as beating the average analyst estimate of $1.08. Wal-Mart also raised its full-year profit forecast after announcing that same store sales had improved each month during the quarter. Wal-Mart’s stock jumped almost $2.00 on the day of the release. This was a nice bounce for the stock, especially after last week’s very rough trading that left Wal-Mart trading around $50/share.
Wal-Mart is the country’s largest retailer, with a market capitalization of $180 billion. Wal-Mart currently sports a very appealing P/E ratio of 11.34, while also paying a dividend of $1.46/share, which generates a return of 2.92% (with the stock at $50). The stock, relatively speaking, is cheap, yet its overall performance in the past decade has been virtually flat. The stock seems to fluctuate back and forth between $50 and $55 per share. Every time it gets above or below that range, it corrects itself, and once again falls back within the range.
I like Wal-Mart as a company, and I especially like them as a defensive play in the event of a double-dip or just a slowing economy. Unfortunately, the stock does not trade to reflect the real value of the company, but this inefficiency in stock price does create an excellent opportunity to sell cash-covered puts on the stock.
Being that Wal-Mart seems to float back and forth between $50 and $55, I think it would make sense to sell some cash-covered puts on Wal-Mart at the $50 strike, the lower end of the range. I particularly like the December 2011 $50 puts for Wal-Mart. Reason being, the puts currently are trading for a nice premium, $2.30/share. Meaning for every contract that the seller sells they will be credited $230 per contract, which at a $50 strike price comes out to be a 4.6% discount on the purchase price.
Selling puts does involve some risk, but if the seller chooses to sell cash-covered puts (as I am suggesting) the risk in the trade is significantly less. The main difference between a cash-covered put and a naked put is that with a cash-covered put the seller actually has the full amount of money needed to buy the stock from the put sale at expiration, if needed (1 put contract = 100 shares of stock). When a naked put is sold, it is sold without the sufficient level of cash needed to cover any stock purchase that might result in the sale of the puts.
Selling puts at the $50 strike price obligates you to purchase the stock at that price for the equivalent number of put option contracts that were sold. At expiration of the option contract, if Wal-Mart is at or below $50, the seller will be obligated to buy shares at that price. If this happens, the seller is still able to keep the premium received for selling the puts originally. This premium will further help defer the cost of buying the stock. If the stock price is above your strike price at expiration, the contracts expire worthless, and the seller gets to keep the premium that they received originally for selling the puts.
I feel that selling puts at the $50 strike provides for a nice entry point into the stock. With a stock like Wal-Mart, it makes sense to sell cash-covered puts on it because it allows you to capitalize on the sideways movement of the stock while still generating a nice return on your money. The beauty with this strategy is that it can be replicated as many times as the seller wants. In the event that the seller ends up having to purchase the stock at $50, I would then suggest selling some covered calls at the $55 strike, the high end of the original price range. This will generate even more income for the investor, again capitalizing on the sideways market action of this stock.
Selling covered calls on a stock that you already own obligates the call seller to sell their corresponding shares of stock at the strike price the calls were sold at. This strategy also works well when the investor wants to create some downside protection on their investment. The call premium that is received for selling the calls can essentially be used as a downside hedge in the event the market sells off. This strategy can also be replicated as many times as the investor would like. The only caveat is that the call seller should be aware that whatever strike price that they pick to sell calls at, they are agreeing to sell their stock (potentially) at that price. Just like the put option contracts, the premium that is received can be kept by the seller regardless of what happens.
The strategy is of selling covered puts and calls on Wal-Mart is an extremely conservative approach, but I feel it generates a nice return on your money, especially in such uncertain times. At the end of the day, no matter what happens in the , will still need to buy the bare essentials -- and Wal-Mart will always be there to provide those products and services.
Disclosure: I am long WMT.
