GMCR Watch

Green Mountain Coffee Roasters Inc. (GMCR) could use an extra jolt of caffeine after a hedge-fund manager talked trash about the company's prospects. Whatever happened to the adage, "If you can't something nice, don't say anything at all"?

sym	phase	trend	adx		200/50	40/10
GMCR

The move at one point carried the price 13.8% below Friday's close.

GMCR is part of my October line-up of covered calls, so I have skin in the game on this one. The move is a text-book example of why covered calls -- generally considered to be a conservative, beginner's strategy -- can at times be such a white-knuckle trade.

The October calls after today have four more days to trade. The decline has brought the stock below my strike price. So in assessing GMCR for my own account, I not only have to look at the four days remaining in my covered call position, but also at the GMCR's longer term prospects. The options won't be exercised, and I shall be left owning the stock.

In this discussion, then, I'll address both issues. First, the stock itself.

The hedge-fund manager whose remarks triggered the decline is David Einhorn. He talked about the company's cash-burn rate, the competitive positions of its K-Cup prices, and -- in a particularly snarky remark reported by Bezinga.com -- said the Q3 earnings are too good to be true.

From the open at $91.75, the price dropped for four hours, breaking below the sideways channel that has been in effect since Aug. 3 before hitting bottom (so far) at $79.33. The price then pulled back to the channel line and at present, that's where it remains.

In terms of my trading rules, it's not really a playable move. The breakout was transitory and the pull-back immediate. So it's just another happy day in paradise.

The intra-day move -- high to low -- was $12.59, a bit less than twice the 10-day average true range. It was sharp decline, but not of a magnitude that the stock doesn't exhibit routinely.

In terms of financials and analyst opinion, I'm extremely bullish on GMCR. The return on equity is 18% -- growth stock territory in my book -- and the debt/equity ratio is 0.23, about double the range that I like but certainly not entirely awful. Institutional ownership is at 81%. When I'm looking at shares, the higher the institutional ownership, the better. These guys have greater resources for analyzing long-term prospects than I do.

Now, Einhorn in his remarks cast doubt on whether the earnings figures could be trusted. But "too good to be true" is not an analysis I can hang my hat on. Absent a better rationale from Einhorn or others, I'll continue to assume that GMCR and its accountants are obeying SEC regulations and the law.

I'll turn next to my specific options position.

I bought the shares at $111.77 and sold an October call with a strike price of 90 for a gain of $23.56, or a gross return of 21.1%. That premium lowered my basis to $88.21.

At the current price, the option won't be exercised, and I'll continue to own the shares after the options expire, and can sell a November call against them. At present, in calculating my return, I look solely at the option premium. The results for the stock itself won't kick in until the shares are actually sold.

In selecting a November call, I can determine my return if the option is exercised by the strike price I select. The formula is:

[November-strike] - [Entry-price] + [October Premiuim] + [November Premium]

Under that formula, the higher the strike, the greater the return. But if the stock isn't exercised, then I've accepted a miniscule return and still own the stock.

I think the choice depends upon whether I expect GMCR to bounce. Next earnings are Oct. 26. Some good strike points to look at are 95 -- the peak a few days before the decline, or 100 -- the mid-point of the channel. The 95 returns an annuallized return of 55%, and the 100, a return of 76%. This is not shabby by any criteria.

The second decision is whether to accept lower premiums by waiting until after the earnings announcement. But since I will own the stock at the time the announcement is made, then the covered call adds very little risk.

Oh, just to hedge my bets, I bought puts today against GMCR. Just a bit of insurance, in case my positive opinion is dead wrong.

Key

• phase: 20-day price channel phase, with green for bull trend, red for bear trend and yellow for neutral trend.
• trend: Price direction, green for higher highs and higher lows, red for lower highs and lower lows, yellow for sideways, and grey for neutral or ambiguous.
• adx: Average directional index location, indicating the strength, or the temperature, of the trend. Orange for 40 or greater, aqua (light blue) for 25 and up but below 40, magenta (light purple) for 20 and up but below 25, and brown for anything below 20. (Mnemonic: Orange for the overhead sun, blue for the surrounding sky, magenta for sunset on the horizon and brown for the earth.)
• 200/50: The moving average cross, green for the 50-day ma above the 200, red for below and yellow for closely aligned.
• 40/10: The moving average cross, green for the 10-day ma above the 40, red for below and yellow for closely aligned.

About my trading methods

Read a detailed explanation of my analysis method, including trading rules.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

The trader’s greatest sin is inaction. Sleeper, awake! Seize the Nietzchean moment. Roll out of bed and trade.