Trading Discretionary Stocks

For the past five years, the S&P/TSX Capped Consumer Discretionary Index has ended December higher month over month from November. It’s a basic seasonality pattern that sees companies in the sector grow in sales and profitability during the peak Christmas spending season. Companies in this sector include an eclectic mix of media companies, fast-food joints, and hardware stores. Sounds weird, I know, but when you think about it, these are the companies that rely on that extra few bucks in your pocket after all the bills have been paid and staples have been purchased.

This year, the sector has been badly beaten down in the general market correction that took hold in July. In fact, it’s down 15% since July and about 20% from its 52-week high posted back in February.
Since early August, the index has been trading in a narrow range between $80 and $85.

An ebbing of consumer confidence in recent weeks, exacerbated by the threat of an economic slowdown in the US and unresolved sovereign debt problems in Europe have resulted in a general flight to safety. But these issues could turn around very rapidly, especially if some sort of eurozone bank bailout plan is approved in the next four to six weeks. This alone could have a salutary effect on markets, resulting in a sharp “relief” rally by year-end. Combined with the onset of the seasonality factor, consumer discretionary stocks could see an outsized spike before Christmas.

Option traders willing to bet on a successful outcome of that combination of events, but mindful of the global uncertainties, might consider mildly bullish positions in select consumer discretionary stocks. Major Canadian retailer Canadian Tire Corp. (TSX: CTC.A, Recent price $59.06), for instance is already starting a move to the upside as sharp-eyed investors cotton on to the seasonality factor.

Thomson Reuters Corp. (TSX: TRI, $29.01) is another company in the consumer discretionary sector that’s been beaten down in the past few months. Thomson Reuters, of course, is the giant globe-spanning data and information services company that’s a stalwart addition to every just about every blue-chip dividend portfolio in town.

Global car parts maker Magna International Inc. (TSX: MG, $37.93) is also poised for a sharp rebound on even the slightest bit of optimism in the broader market, having been beaten down by an unreasonable 38% from its 52-week high earlier in the year.

Because volatility remains high (i.e. option premiums are higher than normal), option writing may be the best bullish strategy in the current environment. Keeping with that theme, look at buying shares of CTC and writing the February 60 calls at $2.75 per share. Return if exercised is 6.6% over four months, return if unchanged is 4.9% and the downside breakeven is $56.31.

For TRI, buy the shares and write the February 30 calls at $1.05. Return if exercised is 7.3% over four months, return if unchanged is 3.8% and the downside breakeven is $27.96. And finally for MG, buy the shares and write the February 40 calls at $2.75 per share. Return if exercised is 13.7% over four months, return if unchanged is 7.8% and the downside breakeven is $35.18.