U.S. Consumers Are ‘Trading Down.’ How to Play It With Options.

A shopper walks past washers and dryers at a Lowe’s home improvement store in Miami.

Joe Raedle/Getty Images

American consumers, one of the greatest economic forces in the history of the world, are nervous.

Investors may be debating whether the economy will fall into a recession as the Federal Reserve normalizes interest rates, but consumers aren’t waiting for an answer. They are changing buying behaviors and trying to save money.

At the grocery store—a place where inflation is pushing prices sharply higher for everything—store-brand goods are suddenly popular. The same is true for off-brand booze and tobacco.

This behavioral shift was last seen during the 2008-09 financial crisis. Back then, the “trading down” phenomenon was first spotted when people stopped going to restaurants. They ate at home to save money. Rather than buying rib-eye steaks, they bought skirt steak or chicken to save money. When white-meat chicken became expensive, they shifted to dark meat.

It is unclear how much of this nascent shift in consumer behavior is priced into stocks or even recognized by investors.

Many retail stocks are vulnerable and weak. While most everyone knows it’s a great time to get a great deal on outdoor patio furniture, it’s not exactly clear how demand destruction might be rippling through the economy. High gasoline prices are painful in a country that relies on cars and trucks for transportation.

To get ahead of the trading-down phenomenon, investors could consider a “put-spread collar”—that is, buying a put option and selling another put with the same expiration but a lower strike price, as well as selling a call option—on the Consumer Discretionary Select Sector SPDR exchange-traded fund (ticker: XLY). The ETF comprises a mishmash of companies—including Lowe’s (LOW) and Tesla (TSLA)—that make their money selling stuff people want but don’t always need.

The ETF’s performance this year has been abysmal. After rallying for the past few weeks, it seems to be struggling to find support. The technical chart shows the stock is curling lower and preparing to give back some, or all, of the 16% rally it has enjoyed since mid-June.

Aggressive investors are trying to profit off the bearish trading pattern, but it’s worth considering a longer view, too. Should the U.S. economy slow as the Fed raises rates—some companies are warning that they might have to right-size workforces like retailers have right-sized inventory—retail spending could suffer.

With the ETF at $148.48, investors could consider buying the January $145 put and selling the January $135 put, as well as selling the January $170 call option.

The put-spread collar is a bearish bet that benefits if the ETF declines to $135. The call sale offsets the cost of the put spread, but if the ETF rallies rather than declines—say, because gas prices sharply decline or consumers will let nothing interfere with their consumption—the call will increase in value. In that event, investors will wish they had not sold it to finance the trade.

The strategy generates a credit of $1.20. The put-spread collar is worth a maximum of $11.20 if the ETF is at $135 at expiration. During the past 52 weeks, it has ranged from $133.04 to $215.06.

The January expiration covers the important back-to-school and Christmas shopping seasons, three meetings of the Fed’s rate-setting committee, and countless economic reports. Investors are increasingly using economic data to refine decisions, and it will figure prominently into determinations if the U.S. economy is down and out or just trading down.

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.

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