Negative Sentiment for Retail Appears to Victimize Dollar Tree (DLTR)

Intuitively, Dollar Tree (DLTR) makes for an intriguing investment during recessionary cycles. While consumer spending naturally declines when the economy suffers headwinds, households can’t cut their budget down to zero. Tied to the retail distribution of low-cost necessary goods, DLTR stock would seem a logical place to park one’s money.

As evidence, DLTR stock is in positive territory this year, gaining nearly 12% on a year-to-date basis through the close of the July 26 session. In contrast, retail king Walmart (WMT) is down almost 16% during the same period. In addition, the benchmark S&P 500 is trading near correction territory, shedding 18% of value.

However, circumstances for the broader retail sector could be changing for the worse. After the closing bell on Tuesday, DLTR stock found itself down 6.3%. Likely, the main culprit was its big-box counterpart Walmart, which endured an even steeper 7.6% decline on the same day.

As the Associated Press reported, Walmart sounded the warning that “inflation is negatively impacting American consumers’ spending power,” per journalist Alex Veiga. Specifically, WMT shares “plunged after the retail giant cut its profit outlook for the second quarter and the full year, saying rising prices on food and gas are forcing shoppers to cut back on more profitable discretionary items, particularly clothing.”

If that wasn’t alarming enough, DLTR stock attracted bearish traders’ attention in the derivatives market.

DLTR Stock and the High-Volume Puts

Following the conclusion of the July 26 session, the options market lit up, shining a rather unfavorable light on DLTR stock. Traders closed in on the $130 puts with an expiration date of Sept. 16, 2022, rounding out the top three in terms of the most unusual options trading activity for the day.

Volume for the put options reached 5,164 contracts against an open interest reading of 157. Moreover, DLTR stock closed in the open market at $157.82, meaning that shares must decline more than 17.6% for the puts to be in the money. With only 52 days left till expiration, it’s a fairly aggressive bet. For context, the 52-week high-low spread is about 110%.

Interestingly, the bid-ask spread for the aforementioned put option as represented by the midpoint price ($2.51) is 7.97%. While not the widest spread in the derivatives market – which tend to have less-favorable spreads when compared to the open market – it’s not the narrowest either. This dynamic suggests that market makers are less confident about properly facilitating this transaction.

Though wide spreads deliver increased profitability for market makers, they’re also unattractive for traders as they impede their net returns. However, too narrow of a spread means market makers would have to operate under razor-thin margins, a risky proposition for volatile stocks.

Inflation Marching on Double Time

Per the aforementioned Associated Press report, investors “have remained deeply concerned about inflation’s impact on company profits and how it will affect U.S. consumers. While Americans’ finances are relatively strong thanks to savings built up during the pandemic, those nest eggs are being spent on high gas and food prices.”

The main problem here is the acceleration of currency erosion in 2022. According to data provided by the U.S. Bureau of Labor Statistics, the purchasing power of the dollar declined by 12.92% since the start of the COVID-19 pandemic, roughly equivalent to 13 cents on the dollar.

However, in 2021, the loss of purchasing power was 6%, whereas in the first half of this year, the loss registered as 5.3%. Essentially, the marching beat of inflation picked up to double time. And unless the Federal Reserve implements significantly hawkish policies, purchasing power could decline even more.

To be fair, Randy Frederick, managing director of trading & derivatives at Charles Schwab stated that the “client base of Walmart is obviously in probably the lower quarter or maybe lower third of the income brackets.” Frederick added that “Those aren’t people that drive most of the discretionary spending anyway, but they are people who are most vulnerable to the inflation pressures.”

However, the issue with this narrative is that at the end of the day, both rich and poor use the same dollar. Therefore, it may be a matter of when inflation will impact more well-to-do households, not if.

A Tough Day for Retail

At some point, investors must figure that the backdrop for DLTR stock should improve. While spending will go down should the economy suffer a recession, it will be reduced largely against discretionary items, with essentials being spared. Theoretically, this should benefit Dollar Tree.

However, in the interim, trading might be volatile. With few good options available at the moment, many market participants could decide to sit out for several sessions until circumstances settle down.

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