How to Spin Retail Fool's Gold into Real Profits

I first heard the phrase "retail ice age" on FOX Business Network "Varney & Co." I don't know if anchor Stuart Varney coined it, but it's a pretty good assessment of the condition of bricks-and-mortar retail in America.

Sure, some down-in-the-dumps retail stocks will bounce if the market keeps on rallying.

But beware - these stocks aren't being bought because they're value stocks. They aren't even good bargains.

There's a reason some of them are moving up, and it's scary.

Here's what turned the retail sector into fool's gold and the smartest way to make money on it...

These Dinosaurs No Longer Rule the Earth

The only issue I have with calling retail's current situation an ice age is that it implies the sector's merely frozen. It's actually not.

What's happening to bricks-and-mortar retail is more like "an extinction event," like dinosaurs dying off.

That's what I call it.

These companies and their stocks aren't facing a cyclical correction, they're facing a secular shift of epic proportions.

The meteor that has exploded onto the scene didn't come from space, but from cyberspace.

Online shopping has changed everything.

Not only can online shopping be done from the convenience of your home or office, from any device, but your purchases can be shipped overnight, sometimes for free. Even when shoppers want to touch and feel something before they buy it in a store, they do their homework online and usually head to the one store where they make their final decision.

The elephant in the room is Inc. (Nasdaq: AMZN).

Amazon's sales went from $16 billion in 2010 to $80 billion in 2016. The online retailer's (or e-tailer's) meteoric rise has been staggering. Several Wall Street analysts estimate that half of U.S. households are Amazon Prime subscribers (even I just became one), though the company doesn't break out Prime members in any of its filings.

Of course, Amazon isn't the only e-commerce game in town. There are millions of web-based companies around the world selling everything under the sun. Almost every bricks-and-mortar retailer has an online presence, too.

While online sales are adding to retailers' top lines, their bottom lines are getting buried under the weight of bricks-and-mortar debris.

For years, bricks-and-mortar retailers misled investors - and themselves - by acting as if their problem was merchandising. In reality, it's a foot traffic problem.

Online shopping drastically reduced foot traffic in malls and shopping centers where retailers had spread themselves far and wide.

As far as retail square foot per capita, the United States has five times more retail square footage per eligible shopper than the UK, 10 times more than Germany, and 20 times more than Canada.

Retailers can't close stores fast enough, though they're trying. Sometimes they're able to reduce square footage and stay alive, but many have had to increasingly reorganize under bankruptcy protection, or liquidate themselves and go out of business.

In just the last three months, according to S&P Global Market Intelligence, 14 chains in the United States have sought court protection while they reorganize their businesses to try and live to sell another day.

Investors have been devastated in the process. But quite a few traders have been making their profits from these dinosaurs' death rattles.

How to Collect Gains All the Way Down

Almost every traditional bricks-and-mortar retailer - and, believe me, there are a lot of them listed on U.S. exchanges - has seen its stock get cut to pieces.

A lot of those stocks look cheap now. They're even being looked at as value propositions by some analysts.

Some have been getting bid up lately, giving them the occasional big up-moves that make financial news headlines.

Don't buy it. It's a trap.

What's really happening in a lot of cases is that these stocks have been sold short by smart investors who saw the demise of bricks-and-mortar retailers coming. They are occasionally taking profits by buying back the shares they shorted as rallying markets draw in investors looking for bargains and so-called value stocks.

So many hedge funds and traders are short these stocks, the thinking on the Street is that the whole "short retail" trade is overdone.

"The short feels crowded to us," said Matthew Weinstein, principal at hedge fund Axonic Capital. "If these defaults start happening soon, the short will work, but if the defaults do not occur quickly, the first guy out could drive the market meaningfully higher."

And that's exactly what's happening.

Moves upward in these left-for-dead stocks are merely shorts covering their positions. When there are a lot of shorts in a stock and the stock starts getting bid up (either by hopeful bargain hunters or clever traders whose play is to buy enough shares to squeeze shorts into buying, driving the stock higher), the unexpected up-move attracts interest.

Don't be duped; these plays are fool's gold.

Most of these stocks are headed back down after this rally peters out, whenever that may be.

The smart way to play these dinosaurs is to play the same games the shorts are playing and the same game the pros who squeeze the shorts are playing... at the same time.

That's how we play them in my subscription newsletter services. You should do the same.

While it makes sense to short a lot of these stocks, it's sometimes better to buy puts on some of them. The returns on successfully timed put options purchases can be staggering.

Depending on the stock and our mathematical expectation for a company to declare bankruptcy based on metrics like its debt, what's left on its outstanding credit facilities, its cash flow and sales, we might buy puts that expire a year out. Or we might buy cheaper put options that expire only a few months out, take profits on those when the stock goes down enough, and buy more puts further out. You can do that again and again, as long as the company and the stock are dying slow deaths.

You can also buy some short-term, near-month call options on some of these deadbeat retailers to profit from the up-moves they enjoy when hard-driving hedge funds squeeze scared shorts into buying back their shorts and driving up prices. We do that, too.

Finding the right stocks to buy puts on and the handful worth buying calls on is the trick.

On Friday, I'll tell you what surprising sector of retail is being hard-targeted by e-commerce marauders and how to play that entire sector. Keep an eye on your inbox.

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The post How to Spin Retail Fool's Gold into Real Profits appeared first on Wall Street Insights & Indictments.

About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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