As Target Tests Resistance, Shareholders Should Consider Protective Puts

Since skimming the $70 level in mid-May, the shares of retail titan Target (TGT) have rallied more than 25%, with help from a post-earnings bull gap. TGT stock has spent the past couple of months consolidating its gains in the $86-$89 neighborhood, but has struggled to conquer the $90 region — home to the stock’s mid-September all-time high, and representing a 50% gain from the security’s Dec. 24 low of $60.15. What’s more, history suggests TGT shareholders may want to purchase protective puts.

Meanwhile, TGT’s short-term options are attractively priced right now. The security’s Schaeffer’s Volatility Index (SVI) of 20.4% is higher than just 10.4% of all other readings from the past year, suggesting near-term options are pricing in relatively modest volatility expectations for the shares.

Over the past five years, there have been seven other times TGT was within striking distance of a new 52-week high while simultaneously sporting an SVI in the bottom 20% of its annual range. After those signals, the stock was lower one month later 71% of the time, and averaged a loss of 4.05%, per data from Schaeffer’s Senior Quantitative Analyst Rocky White. From TGT’s current perch at $87.97, a similar pullback would place the shares around $84.41 — below recent support in the $86 area.

As such, now looks like an opportune time for Target shareholders to lock in gains via protective put options. By purchasing an out-of-the-money put, traders can secure an acceptable sale price for their TGT shares, should the stock take a turn for the worse within the option’s lifetime.

For instance, let’s say Trader Tammy purchased 100 shares of Target for $70 each back in early May. Her ultimate goal is for TGT to extend its recent uptrend, but she’s worried about a possible short-term pullback. With near-term options relatively inexpensive right now, she could buy an August 85 put for just $0.93, or $93 (x 100 shares per option).

Now, let’s say TGT muscles higher, rallying to an all-time high of $95. In this instance, Tammy’s 100 shares are worth $9,500 — a 36% increase from where she bought. The protective put will be deep out of the money, so she’s out $93, but that’s just a drop in the bucket compared to her stock gains.

On the other hand, let’s say TGT does, in fact, retreat, falling to the $80 level. In this case, Tammy can exercise her protective put and sell her 100 shares for $85 apiece, or $8,500 — still a 21% gain on her initial investment. Had she not purchased the protective put, her shares would be worth just $8,000 on the Street — a 14% profit — and that could dwindle even more, if the underlying stock continued to decline.