10 Minute Read

Options Theory: The Walmart Stock Crash & Fading Fear

May 19, 2022

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The bear has come to retail. Walmart & Target sounded the alarm this week that inflationary pressures were coming home to roost. Shares of both retail giants crashed following underwhelming earnings, suffering their largest single-session losses since 1987.

With fear running roughshod through the retail industry, it could be time to trot out the old “Fade the Fear” playbook. First introduced in the Bear Market Survival Guide, the strategy consists of the following:

  • Find an oversold stock/ETF. Preferably one with quality fundamentals and/or that you’re willing to purchase.
  • IV Rank needs to be high signaling options are expensive.
  • Wait for a bullish trigger such as trading above a prior day’s high.
  • Sell short-term far OTM naked put or bull put spread for at least a 10% ROI.
  • To further increase your odds, scale in so that you can add size if the selloff lasts longer than expected. I usually use 3 tiers with the 2nd and 3rd entry capturing 50% to 100% more credit than the first tier.

Currently, Walmart checks all the boxes.

$WMT chart

It’s grossly oversold, has sky-high implied volatility, and is a company with quality fundamentals that I don’t mind owning. The trickiest part of the trade is the timing. There’s no denying WMT is a falling knife. And there’s no evidence yet that a bottom is forming, let alone a pivot low.

But that’s precisely what this particular strategy is designed around. It’s a counter-trend trade that tries to game the snapback when sellers have pushed prices too far too fast. Thus, the lower WMT goes, the more attractive it becomes for this trade. Right now, we’re down three consecutive days following the disastrous earnings report. Will we fall a fourth or fifth day? Maybe. So far Thursday’s candle is showing slowing momentum, so there’s a chance a pivot low looms.

For now, I like using Thursday’s high as the trigger point. I would lower that each successive down day so that we trigger on the first up day.

Which Bull Put Spread?

Given the slightly higher share price, a bull put spread is the easier trade here. Currently, the June $110/$105 bull put spread is trading for around 60 cents. Thus, if I was scaling in, my entry for three tiers would be 60 cents, 90 cents, and $1.20.

If we’re lucky and WMT falls significantly further before triggering, we may be able to shift the strike prices down to $105/$100 but right now that spread only fetches 32 cents. I need at least 50 cents to make it work.

The bet is not that WMT will rise aggressively from here, though that would certainly help. Instead, when Fading the Fear we’re more so wagering that puts have become so expensive that it’s unlikely the stock will fall far enough to justify the prices people are paying. Thus, we can still win if WMT falls further. It simply can’t fall too far.

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