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Target is a standout, but watch for higher oil prices – Options Strategy

May 07, 2011 4:44 PM ETTGT, OIH, OIL-OLD
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Looks like Target shares are on the rise.  Recent data (including 13.1% jump in April same store sales and a pause in the rising oil prices) supports this positive sentiment.  Thursday’s broad market sell off did not affect the ascending trend of the company’s shares.  However, the implied volatility remains relatively low.  Yesterday (Friday, May 6th), the June 55 calls were at 21% and could be purchased for only 19 cents. 
However, if history is any guide, resumption in the oil rally will negatively affect the retailers in general, and TGT in particular.  
Therefore, to mitigate the risk of rising oil prices in order to protect the long call position, it is prudent to buy some bullish oil-related strategy.   
We can use oil services ETF (OIH) as a proxy for rising oil prices.  Establishing calendar call spread makes sense in light of the current volatility levels for the OIH. For example, consider the June/July 160 strike calendar spread (write June 160 calls and simultaneously buy 160 July calls). If the oil prices decline/stay the same at June expiration, this spread will result in June short calls expiring worthless and additionally investor enjoying “free” July long calls afterwards.  In case the oil keeps climbing, both legs of this position would have to be closed with a net credit, reflecting the higher volatility of the July calls.

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