Is it Time to Dump Retail?

On Wednesday, October retail sales data showed a seasonally adjusted decline of 0.3 percent, versus expectations of a 0.1 percent decline. This was the largest drop since June, and followed a strong 1.1 percent advance in September.

Is it Time to Dump Retail?
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The SPDR S&P Retail ETF sold off 1.2 percent on Wednesday, which was in line with the S&P 500's decline. But the XRT saw heavy options trading Wednesday as traders rushed to buy puts, sending XRT's put/call ratio to 50.6 for the day.

The day's biggest trade was the purchase of 23,000 December 60-strike puts for $1.67 each, and the sale of 23,000 December 56-strike puts for $0.49 each. This is known as a "bear put spread" and will profit if XRT is below $58.82 at December expiration.

So why is this bearish? Let's break it down.

This trader is buying an out-of-the-money put, which will rise in value as the stock declines. However, to subsidize those costs, the trader is also selling a further-out-of-the-money put. This decreases risk by reducing the total premium paid, but also limits the additional profit that this trade will see if the XRT dives below $56 by December expiration.

However, if XRT does end up below $56, this spread will realize a full value of $4.00, thereby returning a profit of $2.82 (or a 239 percent return on risk). So it would be hard for the trader to complain.

But let's zoom out. Why were so many traders getting bearish on Wednesday?

Well, if you dig into the retail sales report numbers, it's easy to find some sources of concern. The only sectors that saw a meaningful increase in sales were service stations and grocery stores. (Read More: Retail Sales Sag.)

Auto dealerships saw a 1.5 percent month-over-month decline, which is the largest drop in a year. Service station gasoline sales jumped 1.4 percent last month, and if we omit this figure, we would find that retail sales fell an even sharper 0.5 percent last month.

Grocery store sales were likely up as a result of super storm Sandy, and do not represent real demand or growth. And sales in sectors that I would have expected to benefit from the storm—such as home improvement stores—actually declined. (Read More: Super Storm Sandy Leaves Mark on Retail Sales.)

With all that said, let's not jump to any big conclusions. This report was clearly affected by Sandy, which has increased the volatility of recent economic data. Indeed, retail sales reports are typically volatile to begin with, and it is not uncommon for large increases to be followed by declines.

That is why I am not getting short the retail sector. Still, I do feel that long stock positions should be protected by puts or put spreads. There is no denying that this was a poor report, and that it could lead to more selling in the coming days.

Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."

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