Wal-Mart and Amazon Reenact Naval Battle
 |
Matthew Buckley Check6-llc.com |
|
On March 9th, 1862, at Hampton Roads, Virginia, the future of naval warfare was changed forever.
Two ironclad warships faced off in an epic battle for the first time. The CSS Virginia (formerly the USS Merrimack) battled the USS Monitor for hours, as their respective flotillas watched and spectators lined the shore. The ships traded cannon fire and each ship landed a couple of hits, but each also sustained some damage. Unable to knock each other out, both retired from the engagement, believing the other retired first. Both sides claimed victory.
147 years later we’re about to witness a similar duel between two business ironclads and it remains to be seen who will retire first, if at all. If I was a betting man, and I am, I think we may see the same result.
Wal-Mart (WMT), the behemoth brick and mortar retailer, launched the first broadside in a modern day battle against online heavyweight Amazon (AMZN). Wal-Mart fired the first shot by announcing they would sell 10 of the hottest new books online for $10. Amazon quickly returned the broadside by lowering their price to $9, which Wal-Mart immediately matched. The last round of the initial volley had Wal-Mart knocking a penny off, reducing the price to $8.99.
Target (TGT) joined the battle and matched Wal-Mart, while offering free shipping.
This battle is occurring at a crucial time. Retailers are consulting their crystal balls to predict how bad (or good) the upcoming holiday season will be and this battle has clouded their view. Wal-Mart’s attack on Amazon doesn’t consist solely of books. The world’s largest retailer is pushing into other products on their Walmart.com site as well.
As we’ve seen in the airline industry, trying to beat your opponent solely on price is an unsustainable battle. An airline launches a low fare offer, only to be matched by the competition. Then it’s a race to the bottom to see who blinks first. But often times the winner ends up the loser as they fly a packed airliner for a loss. The airline graveyard is littered with companies who engaged in this strategy. While Amazon and Wal-Mart won’t be going out of business anytime soon, the price war may result in a stalemate.
These back and forth skirmishes are tactical in nature and not strategic. Tactics can be replicated, while strategy is harder to copy. Years ago while airlines were locked in tactical battles such as price or offering in-flight movies, Herb Kelleher developed a new and unique strategy: people want to get safely from point A to point B, without having to connect and run to another gate, and they don’t want to pay a lot for a ticket. Southwest Airlines (LUV) was born and the rest is history.
Amazon has the advantage of online brand name recognition, along with an established and efficient online ordering infrastructure. Wal-Mart lacks these advantages. In some ways, Wal-Mart may be falling victim to Google’s (GOOG) “we can do everything” disease. Reminds me of a saying, “Plumbing can’t be hard…plumbers do it…”
On the other hand, it is Wal-Mart and they have the resources to make this a serious battle. Wal-Mart isn’t afraid to throw a little cash at this effort, and they regularly run national television advertising campaigns. It remains to be seen what other retailers with online storefronts will do. Ebay (EBAY), Costco (COST), and Barnes and Noble (BKS) need to take notice and strengthen their fleets, or face losing market share.
As options traders, we don’t need to sit on the shore and watch this battle; we can profit from it.
For the past 6 months Amazon has found support at the $75 level, while reaching the $95 flight level. If an investor thinks AMZN will continue to trade in a range and climb a little higher as they exchange broadsides with Wal-Mart, a December iron condor might be attractive. An investor could sell the December 75/85 bull put spread and the December 105/115 bear call spread for a net credit of $3.35. With at-the-money volatility of 40.8%, there’s a 48.03% chance of AMZN finishing between 85 and 105 by December expiry, where maximum profit occurs (the net credit of $3.35). The maximum risk of this trade is the difference between the sold and purchased strikes, minus the total premium collected, or $6.65.
This is a 50% return on risk. Nice return, but an investor needs to remember there’s just under a 50% probability of this occurring.
There are 2 breakevens for this trade. The upper breakeven is 106.48 (the strike of the sold call plus the premium 1.48), and the lower breakeven is 183.13 (the strike of the sold put minus the premium). Plug these 2 breakevens into the black box and one discovers there’s a 54.55% probability of AMZN finishing between the 2 breakevens. What I like about iron condors is that you can only be wrong in one direction; the stock can’t hit both credit spreads.
Wal-Mart has seen a recent run from 49 to 52, and a bullish investor could consider a bull call spread, or simply buy an at-the-money or in-the-money call. The Dec 50 calls have a delta of 71 and the Dec 47.5 calls have a delta of 86. When I buy straight calls, I like looking for a delta of around 70 to 80 to see a rise in premium close to that of the stock.
I believe this battle may end like that historic day during the Civil War, with both giants leaving the battle bruised but not defeated.
Watching from the shore, one can only marvel in the awesome power of 2 giants engaged in a spirited battle, trading glancing blows. But from shore it’s easier to notice the storm on the horizon, which, if it arrives, could damage both warriors.
Any trade ideas discussed in this article are starting points for readers to conduct their own research. Trading ideas are not intended as trading or investment advice or recommendations that any particular security or strategy may be suitable for any specific reader. You are solely responsible for your investment decisions. Options involve risk and are not suitable for all investors. Please visit the OIC website www.888options.com for more information and read Characteristics and Risks of Standardized Options at http://www.optionsclearing.com/publications/risks/riskchap1.jsp
Matthew "Whiz" Buckley is the Managing Partner of Check6 LLC, a business-consulting firm specializing in leadership development, risk management, and strategic planning for Fortune 500 companies and related organizations. Whiz flew the F/A-18 Hornet for the U.S. Navy. He's a graduate of TOPGUN, has close to 400 carrier landings, and flew 44 combat sorties over Iraq. He transitioned to the business world after he was scheduled to fly his first flight as an airline pilot on 9/11. Instead, he ended up flying combat air patrol over the U.S. He rose rapidly though corporate America, starting as Managing Director of Strategy at PEAK6 Investments, to CEO of the Options News Network. He is an internationally recognized speaker and combined his unprecedented experiences in the military and corporate America in the writing of From Sea Level to C Level. You can follow Whiz on Twitter.