Wednesday, March 6, 2013

GPS: Recovering from a correction

Update 4/21/2013: The vertical credit spreads that I retained have expired worthless, for a yield of 15% calculated as a portion of the amount risked.

Update 3/26/2013: GPS fell below its 10-day price channel on Tuesday, March 26, signalling closure of part of my complex bull position.  The initial position was a vertical credit spread with an underlying basis of $34.54. It remains profitable and, with its cushion, will become loss-making only below $32.47. I'm retaining that portion of the position in the hope of capturing a profit if it expires above that level. Long calls added to the position on three occasions as the price rose were sold for a 3.3% loss on the underlying, calculating from their combined basis of $36.38. The loss on the calls themselves, factoring in the leverage, was 25.4%.

Gap Inc. (GPS) broke above its 20- and 55-day price channels on Tuesday, sending a bull signal as the stock attempts a recovery from a correction that carried the price from $37.85 in October down to $29.84 in December.

The break above the $34.29 channel boundary was the 14th bull signal since the broad market began its post-recession recovery in early 2009. Nine of those breakouts was profitable, for a success rate of 55.6% and an average gain of 15.8%. Adjusting the gain by the success rate produces a high score 8.8%.

Since October's post-recession swing high, $37.85, the stock has sent five bull signals, and four of those have been successful, for an average yield of 16.6%.

If the present rise continues and breaks above the swing high, then GPS will have set a higher low followed by a higher high, keeping the longer term uptrend intact.

The Gap, headquartered in San Francisco, California and doing business under the names Gap, Banana Republic, Old Navy, Piperlime and Athleta Gap, is the largest specialty retailer in the United States. It operates more than 3,000 stores globally.

Analysts collectively give Gap a negative 18% enthusiasm score, something less than a whole-hearted endorsement.

Certainly the company's current performance deserves better, with a return on equity of 38% and debt amounting to 43% of equity. The debt is higher than I like but is not at crippling levels by any menas.

The company has been profitable for at least the last 12 quarters, The company stumbled in 2011 when the all-important Christmas shopping quarter came in with lower earnings than the year before, but the 2012 quarter exceeded its comparable quarters of the last two years.

Gap has surprised to the upside all 12 quarters.

Institutions own 51% of shares and the price is almost precisely on parity with sales. It takes $1.08 in shares to control a dollar in sales.

GPS on average trades 5.1 million shares a day, sufficient to support a good selection of options strike prices with open interest running in the three- and four-figure range. The front-month, at-the-money bid/ask spread on calls is a low 2%.

In the analysis that follows I use the statistical concept of a standard deviation, boundaries that encompass 68.2% of trades around a certain point.

Implied volatility stands at 31% and has been declining sharply over the past week.

Options are pricing in confidence that 68.2% of trades will fall between $31.48 and $37.56 over the next month, for a potential gain or loss of 8.8%, and between $33.06 and $35.98 over the next week.

Options speculation is on the quiet side, with both calls and puts trading at about a third of their five-day average volume.

The fair-price zone on today's 30-minute chart runs from $34.46 to $34.73, encompassing 68.2% of transactions surrounding the most-traded price, $34.55. GPS has traded within the zone in the first two hours of today's trading.

Gap next publishes earnings on May 20. The stock goes ex-dividend on April 8 for a quarterly payout yielding 1.74% annualized at current prices.

Decision for my account: I've opened a bull position on GPS structured as a bull put spread expiring in April, short the $33 put and long the $30 put. That structure provides a 15% maximum yield and is profitable down to $32.47, slightly below the initial $32.71 stop/loss.


My trading rules can be read here.  A discussion of recent modifications to my trading methods, which haven't yet been incorporated in the original write-up, can be found here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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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