The economy might be heading toward a recession—at least that's the sentiment among investors focused on discount retailers. Last week, Dollar General (DG) issued a downward revision of its forward guidance after a disappointing fiscal second quarter. In response, shares of direct competitor Dollar Tree (DLTR) also fell. With DLTR's earnings report looming, all eyes are now on the stock.
Given the harsh response to Dollar General’s report, investors are understandably nervous. Over the past five sessions, DG stock has plummeted by more than 33%. As highlighted by Barchart content partner The Motley Fool, Wall Street reacted negatively to DG’s lowered full-year guidance. Management initially projected net sales growth of 6% to 6.7%, but this has now been cut to a range of 4.6% to 5.3%.
As TMF noted, “the company has annual sales of nearly $40 billion, so even a small percentage change in its growth rate is substantial.” Additionally, Dollar General revised its earnings per share (EPS) guidance to between $5.50 and $6.20, compared to $10.68 in 2022. Faced with this grim outlook, many investors have exited their positions in DG.
This scenario casts an unflattering light on DLTR stock. Dollar Tree targets a similar customer base as Dollar General, and with its rival under significant pressure, some investors may favor a neutral or bearish options strategy, such as a bear call spread.
However, it’s possible that the market has already priced in the bad news for discount retailers. In that case, even a modestly positive surprise in Dollar Tree’s earnings could lift DLTR stock. With this in mind, a different approach might be worth considering.
DLTR Stock Could Benefit from a Bull Put Spread
On Friday, Barchart’s options screener identified a potentially profitable strategy for DLTR stock: the bull put spread. Rather than betting solely on a price increase, the bull put spread is a wager that the stock will either stay steady or rise. Even if the stock declines, the structure of the spread limits the potential downside risk.
Here’s how the strategy works:
- Sell the DLTR put (expiring on Sept. 6) with a $75 strike price at a bid of $1.38.
- Buy the DLTR put (same expiration) with a $70 strike price at an ask of 65 cents.
The key statistics are:
- Breakeven price: $74.27
- Maximum profit: $73 (the income from selling the $75 put minus the premium paid for the $70 put, multiplied by 100 shares).
- Maximum loss: $427 (the difference between the strike prices minus the net premium received, multiplied by 100 shares).
This strategy hinges on DLTR stock staying above the breakeven price. Given that the stock closed Friday at $82.97, the price would have to fall 10.5% to hit breakeven and nearly 16% for the maximum loss to occur.
While a drop of this magnitude is possible, it’s also plausible that Dollar General’s recent struggles have set a low bar for the entire sector. Any positive news from Dollar Tree could result in a minor lift for DLTR stock. If the stock simply remains stable, the bull put spread will still generate a profit.
Unusual Options Data Adds a Twist
One factor worth noting is the unusual options volume for DLTR stock. According to the data, professional traders seem heavily involved.
At the end of last week, total volume for DLTR options hit 50,561 contracts, while open interest stood at 255,460. Friday’s options volume was 202% higher than the trailing one-month average.
Interestingly, call volume reached 24,042 contracts, while put volume was slightly higher at 26,519 contracts. Options flow data—which tracks large block trades from institutional traders—revealed a net bearish sentiment, with a net trade sentiment of -$1.17 million, suggesting that big-money players are expecting further downside for DLTR.
Adding to this bearish sentiment, Barchart’s Technical Opinion indicator ranks DLTR as a "100% Sell." While not encouraging, this could also mean that investors are betting on the obvious outcome.
However, markets don’t always follow the obvious path. Given that Wall Street may already be primed for bad news, any positive surprise in Dollar Tree’s earnings could lead to an outsized reaction. In such a scenario, a bull put spread could turn out to be the right move for traders this week.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
