Thursday, July 12, 2012

GPS: Parsing a near-term correction

It is oh so tempting to ascribe personality to stock charts. Gap Inc. (GPS), which markets clothing and accessories through The Gap, Old Navy and Banana Republic retail stores, has been resting since April, exhausted by a mighty push that saw the stock gain half its value in only a few months.

I can see it now: Gap, sitting on a bench in a San Francisco park, breathing hard -- gasping, really -- as it tries to get its breath back so it can redouble its efforts.

Or not. There are never any guarantees in the markets. Only guesses, trends and gaps.

GPS began its sharp rise on Feb. 1, gapping up 8% from the prior day's close of $19.45. The uptrend ended, or at least paused, on May 1 at a high of $29.23.

Since then, GPS has retraced back to $25.02 on June 4, and since then has begun a gentle rise toward its peak in a series of higher highs and higher lows -- an uptrend.

The last three days have seen a retracement within that uptrend that has remained above the prior low. The uptrend remains in place, and today is showing a hesitation pattern on the chart, with little difference (so far) between the open and the current price.

If that hesitation pattern holds today, and if  GPS sets a higher high tomorrow (compared to today), then I would conclude that the uptrend since June 4 remains in place. A fall below $25.02 would negate the uptrend, removing it from my consideration for a bullish position.

Assuming that I would want to trade. Analysts are pretty down on Gap. Enthusiasm among the 24 analysts tracking the stock is at a negative 21%, the same as a month ago. So a bull position on GPS is runs counter to the consensus.

Not that I always follow the consensus. Analysts have no crystal ball, anymore than I do. The future is opaque to all traders, providing a level playing field for our games.

GPS recommends itself for consideration for reasons removed from the chart and the analysts. We're deep in earnings season. My rules won't let me open a new position within a month of a stock's earnings announcement.

Gap doesn't announce earnings until April 16, giving me a window for a short-term trade.

The company reports return on equity of 25% with long-term debt running at 54% of equity, higher than I like but not crippling. 

Annual earnings accelerated from 2007 through 2010. The 2011 fiscal year, ending Jan. 31 this year, showed a drop below the 2009 level.

Like all retailers, Gap's best quarter tends to be the 4th, covering Christmas shopping. The 2011 4th quarter earnings showed a 27% drop from the quarter before.

But that year-over-year decline came in a quarterly earnings uptrend, which continued in the 1st quarter 2012 with earnings above the prior quarter's. Normally the 1st quarter drops from the 4th. But not this year.

If it were a stock chart, I would say that quarterly earnings are in an uptrend within a correction, having reached 47 cents per share, and that the uptrend will be confirmed if quarterly earnings exceed 60 cents a share.

Each of the past 12 quarters has been profitable and shown an upside earnings surprise.

Institutions own 54% of shares, a bit on the low side for a major player like Gap. The price is slightly below sales parity. It takes 90 cents in shares to control a dollar in sales.

GPS on average trades 5 million shares a day, sufficient to support an adequate selection of options strike prices with narrow bid/ask spreads. Open interest, however, is spotty, concentrated in just a few strikes, suggesting to me that there's some heavy speculative play going on.

Call options are trading at more than double their five-day average volume, and puts at less than half the average volume.

Implied volatility stands at 39%, about midway through the six-month range. Options are pricing in confidence that 68.2% of trades will fall between $23.99 and $30.01 over the next month, for a maximum gain or loss of 11%.

The stock is trading below five-day fair-trade range, which runs from $27.41 to $28.50 and contains 68.2% of trades for the period. The most traded price is $28.01, and the most traded prices today are a tie among $26.98, $26.99 and $27.

Gap next publishes earnings on Aug. 16. It goes ex-dividend in September for a quarterly payout yielding 1.85% annualized. That puts the dividend outside the window of an August options trade, a good thing since a dividend increases the odds of a short option being exercised.

Decision for my account: There's a lot not to like about the GPS: The negative analysts, the long-term earnings trend. But I like the chart, at least if the very-near-term downtrend reverses after today (as discussed in my chart analysis, above). 

I said above that it would take a higher high on Friday to persuade me to trade GPS. The reversal pattern for today is strong enough that I've jumped the gun and opened a position. I structured the trade as a bull put vertical spread expiring in August, short the $27 put and long the $24 put, for an 86 cent credit. The position is profitable at expiration down to about $26.12 and has potential profit of 40% of risk.

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.

No comments:

Post a Comment