Playing the Retail ETF ‘GAP’ Down

On Friday the Street reacted violently to news from clothing retailer The Gap Inc. (NYSE: GPS), which slashed its profit outlook for the year due to an estimated 20% rise in costs per-unit. The company attributed those increased costs to surging cotton prices and warned that it would not be able to fully pass on these increased costs to consumers. The gloomy outlook caused GPS shares to plunge 17% in Friday trade.

As you might expect, the selling in such a high-profile retailer weighed down other stocks in the space, including fashion retailers Ann Taylor Stores (NYSE: ANN), Limited Brands (NYSE: LTD) and Urban Outfitters (NASDAQ: URBN). What do all three of these companies have in common? They are all components in the SPDR S&P Retail ETF (NYSE: XRT), an exchange-traded fund pegged to the S&P Retail Select Industry Index.

This broad-based measure of the retail segment doesn�t just hold companies that are �ber-sensitive to rising commodity costs, yet consumers who patronize these retailers are feeling the purse-tightening sting of higher food and energy prices. Higher commodity costs for clothing sellers, combined with less money in consumers� pockets, is a potent poison for the retail sector. However, that poison just might be a prescription for profits for intrepid bear-minded investors, especially for options trading investors.

A look at the XRT chart shows that over the past three months buyers have ruled the roost. The fund is up nearly 7% during that time, and if we take a step back we find that XRT has delivered a 33.4% gain over the past 12 months.

Yet if the problems at The Gap — along with the aggressive selloff in GPS — are a harbinger of things to come in the sector, we could see a significant selloff in the space. For options traders, buying the XRT Jun 51 Put could produce outstanding upside. The option jumped over 30% in Friday trade alone, and that shows you the power of betting on The Gap-down in the space.

Another way to play a potential fall in retail stocks is via the Retail HOLDRs (NYSE: RTH). This ETF also counts Gap and Limited Brands as part of its top holdings, as well as retail giants like Walmart (NYSE: WMT), Home Depot (NYSE: HD) and Amazon.com (NASDAQ: AMZN). These stocks all depend on vibrant consumer spending for their good fortune, and if that spending is significantly curtailed due to higher food and energy costs, it could put additional pressure on RTH. Taking advantage of that pressure with an option like the RTH Jun 110 Put, which rose 66% on Friday, could put traders in a very good mood.

If you aren�t an option player, then don�t worry, there�s an ETF out there designed to take advantage of the slide in the retail space, and it�s the Direxion Daily Retail Bear 2X Shares (NYSE: RETS). This fund is designed to deliver twice the inverse performance of the Russell 1000 Retail Index. That means if the Russell 1000 falls 2%, then RETS is designed to rise 4%. This leverage makes RETS a good trading tool for bearish retail investors looking to double-down on their bets against the sector.

At the time of publication, Jim Woods held no positions in any of the stocks mentioned in this article.