Option traders play it safe with Kroger results

(Reuters) - Some options players are taking a cautious stance on Kroger Inc (KR.N) heading into the grocer's quarterly earnings before the market open on Thursday.

Analysts expect the biggest U.S. supermarket operator to report first-quarter earnings of 73 cents per share, up from 70 cents per share a year earlier, according to Thomson Reuters I/B/E/S.

Concern that a pullback in U.S. consumer spending could dent Kroger's business fundamentals has investors increasing their use of put options.

"As Kroger shares have been under pressure especially since early April, put volume has grown," said ITG director of derivatives strategy Ralph Edwards.

Stockholders often protect themselves from declines in share prices by buying equity puts, which are contracts that convey the right to sell shares at a fixed price by a certain date.

Options are also pricing in the potential for a fairly big move in Kroger shares post-earnings, uncommon for the grocer, which is usually not a volatile stock.

Kroger shares are down about 13 percent since the beginning of April. Shares of Wal-Mart Stores Inc (WMT.N), which sells more groceries than any other U.S. retailer and is viewed as a recession play, are up more than 9 percent in that period.

Derivative strategists at Goldman Sachs Group recently advised clients to buy a June put spread on Kroger as recent data points suggest risk to earnings.

"Weakening personal consumption expenditures on food at home, increasing market share for Wal-Mart and moderating inflation suggest risks to management's ability to deliver on current guidance," Goldman Sachs strategists wrote in a May 31 report. Goldman Sachs grocery analyst Stephen Grambling sees 6 percent downside to sell-rated Kroger with $21 as his 12-month price target.

PUTS HEAT UP

On Wednesday, a buyer was active in the June $21 strike puts, paying up to 39 cents per contract for options that need to have the stock move to $20.61 in the next two days just to break even on the trade, Edwards added. June options have two days of life remaining after the company reports results.

In all, 9,945 contracts traded in that strike against open interest of 2,747, data from Trade Alert showed.

Heading into earnings, option turnover swelled and was 11.4 times the average daily levels with 15,000 puts and 6,426 calls traded in Kroger on Wednesday, according to options analytics firm Trade Alert.

Kroger options are implying a swing of about 5.7 percent in either direction for the shares as of Wednesday afternoon, Edwards said, who derives his calculation by using the difference in option pricing between the two front month at-the-money contracts.

While a five percent move may not seem extreme, grocers have not historically been thought of as volatile stocks, Edwards said. Kroger's median post-earnings move is 2.04 percent since the fourth quarter of 2010, according to Birinyi Associates.

Some analysts expect the company's first-quarter results to top forecasts as it continues to take market share from rival chains like Safeway Inc (SWY.N) and Supervalu Inc (SVU.N).

For example, BB&T Capital Markets analyst Andrew Wolf expects Kroger to report earnings of 74 cents per share, which would top expectations by 2 cents per share.

Many investors have played it cautiously of late. During a 10-day period beginning May 30, investors bought 5.7 Kroger puts for every one call on three U.S. options exchanges as fresh positions, according to options research firm Schaeffer's Investment Research.

That put-to-call ratio is higher than 83 percent of the readings taken during the past year, suggesting significant pessimism ahead of this report, said Joe Bell, Schaeffer's senior equity analyst.

However, that sets the bar low if there is any good news. "If the earnings reaction is positive, traders may rush to close their bearish positions, adding fuel to a rally," Bell said.

To be sure, not everyone is so pessimistic about Kroger's outlook. The second most active option on Wednesday is the June $21 KR strike calls which expire on Friday.

Kroger shares closed down 21 cents at $21.29.

(Reporting By Doris Frankel; Additional reporting by Lisa Baertlein in Los Angeles)