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Retailers Responding

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The impact to consumer spending could hold the key to an economic recovery, and tomorrow we get a peak at post-tragedy consumer confidence figures. An earlier survey conducted by The Conference Board has revealed that only 10.5% of consumers plan to postpone purchases of non-big ticket items. A survey is one thing, but breaking out the wallet is another. Retail stocks stand to be impacted the most.

Retail Index Weekly Chart

The Retail Index (RLX.X) is up 5.79% today, which almost erases half last week's 82-point drop. Today's reversal came at the October 1998 lows and 61.8% retracement of those gains. That level should offer support going forward, but 750, the 50% retracement level, might provide resistance. September sales, which aren't released until October 11th, could tell if resistance at 820 is tested in the future. As I walked through Sears over the weekend, Christmas displays being set up reminded me that this test of consumer confidence is coming right at the critical holiday shopping season.

Bed Bath and Beyond (BBBY) is up 14.32% today after an upgrade from Merrill Lynch. Merrill cut 2001 estimates by 1 cent a share, but likes BBBY's sector leadership, strong management and consistency.

On the other hand, shares of Dollar General (DG) are down 25% due to accounting irregularities. The company plans to restate its financial statements for the past three years, and change the way it accounts for certain leases and liabilities.

Jeffrey Canavan

Inter-Sector Trade

Of the 34 components of the Retail Sector Index (RLX.X), only a handful are under performing the broader market. Two of the stocks in the group are actually lower today: CVS (NYSE:CVS) is still feeling the negative impact of its earnings warning last week and Dollar General (NYSE:DG) announced it had fired its auditor this morning.

Ahead of the consumer confidence numbers Tuesday morning, the retail group could be set up for a big move. The direction is obviously unknown, but traders can set up an inter-sector trade ahead of the report in an attempt to reap any benefits of a large move in the group.

One strategy to consider in this instance is a hedged bet on an equal ratio basis. That is, entering an equal amount of long and short positions. That way, a trader can have both long and short exposure ahead of the report, because at the time of the report Tuesday morning, trading in these issues will most likely be illiquid and fast.

Akin to the options strategies of a strangle and straddle, an equal ratio of long/short positions in the underlying allows a trader to take advantage of any forthcoming move that is expected to be large while the direction is unknown. In this case, using the underlying instead of options is preferred due to the relatively high implied volatility in options contracts and the ramifications of September expiration last week.

When employing a long/short trade in the underlying stock within a specific sector, a trader obviously wants to buy the strongest stock and short the weakest stock. The aim is that the strongest stock should advance more on positive news that the weakest stock. Conversely, on negative news, the goal is to short a stock that will drop faster than the stock that was bought.

In the case of the retail sector, one of the strongest stocks in the group is Office Depot (NYSE:ODP). As Jeff Bailey recently pointed out, demand has been building in this stock for some time. That much is obvious on the point & figure chart.

Shares of Office Deport are up by about 6 percent at the time of this writing. The stock is performing about in-line with the RLX today. Other stocks in the group are outperforming the RLX today, but the majority of their charts have suffered serious technical damage in recent weeks. And it would appear that a great deal of the strength in shares of Target (NYSE:TGT), for example, is short covering.

Meanwhile, shares of Federated (NYSE:FD) are under performing the RLX today. The reason I was attracted to Federated is because the stock has been under performing the RLX for quite some time as is the case again today. Other stocks within the group such as TJX Companies (NYSE:TJX) and Safeway (NYSE:SWY) are performing much worse today, but that's been the case for Federated for longer than just today. In fact, of the three aforementioned stocks, only Federated is on a sell signal on its relative strength chart versus the RLX.

Of course if a trader were to implement this strategy, they would want to have the necessary risk management procedures in place on both sides of the trade.

There's no such thing as a sure trade in any market. However, it's the trader's aim to put the probabilities in their favor. And that's what this type of trade will do.

Eric Utley
Option Investor

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