Tuesday, March 20, 2012

AAP: All the parts in place

Advance Auto Parts Inc. (AAP) sells after-market parts for cars, vans, SUVs and and light trucks, targeting people who like to get down and greasy under the hood, either on their car or someone else's for money.

The Roanoke, Virginia company operates more than 3,500 retail stores in the eastern and midwestern U.S., Puerto Rico and the Virgin Islands.

AAP had the most bullish chart of 16 stocks selected at random from 675 large-cap companies. FTI was the runner up. ETN and VIV completed the final four.

The AAP chart began its current rise on Jan. 4, 2012 at $69, moving quickly into blue-sky territory where it has remained ever since. An upside earnings surprise in mid-February resulted in a $4 gap, helping to propel the price up to a highest high of $89.50 on March 16.

The price immediately drew back from that level but is again approaching a fresh breakout.

The prudent trader will wait for a persistent break above $89.50. Traders with confidence in their position management skills will go in now to capture any explosive breakout to the upside.

The company is certainly a money-maker, with a return on equity of 42%, but with long-term debt amounting to 49% of equity, quite a high level.

Institutions own 94% of shares, yet the price is near parity with sales. It takes only $1.05 in shares to control a dollar in sales.

The analyst consensus rates AAP a moderate buy, meaning it is expected to outperform the market by a bit.

Bottom line: All the parts are in place for this stock. The only downside, a very slightly, is liquidity.

Average volume is 883,000 shares, and that results in slightly wider bid/ask spreads on the options than I like. Three-figure open interest is clustered around the at-the-money mark and rapidly trails off to zero as the strike price moves away in $5 increments.

Implied volatility is at historic lows, suggesting that any position I were to open should be long.

That means theta negative, in options parlance: I should open a position where time decay decreases the value, especially in the last month before expiration.

The reason for that seemlingly counter-intuitive tactic is that to buy a position is to buy volatility, and as with anything else, a trader wants to buy low and sell high. Implied volatility is way low, and in theory it will at some point revert to the mean by rising.

The implied volatility provides a 68.2% confidence that the price will close between $82.77 and $95.23 a month from now.

Decision for my account: I've opened bull call vertical spreads on AAP, for a net debit, going long the $85 call and short the $90 call. The position expires in September.

I screened the stocks using a tourney bracket with a one-month daily chart and a three-day half-hour chart, and then turned to a five-year weekly chart for the broad context in analyzing the bracket winner. See my essay "10,000 Charts" for a discussion of my screening methods.
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.

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