Thursday, April 11, 2013

GPS: Back in the bull column

Update 5/30/2013: My bull position in GPS, structured as vertical credit option spreads, expired on May 17. Earnings were to be announced on May 23, so I held back from rolling the position over to June spreads. 

Good thing. The stock price dropped after the announcement and on May 29 pierced the lower boundary of the 10-day price channel, providing an exit signal. In this case, exit means I no longer intend to roll the shares forward and have declared my GPS position to be closed until the next bull or bear signal puts it back on my agenda.

The stock closed on May 17, my exit day, 8.5% above the price at the time I opened the position. I added to the position three times and the overall price gain for my basis was 7%.

The options provided a yield of 28.4% of the amount I had risked.

The Gap Inc. (GPS) broke above its 20-day price channel on Wednesday, sending a fresh bull signal 10 days after its previous bull phase closed. The break above the price channel boundary, $37.00, was confirmed in trading today as GPS moved still higher.

It was GPS's 16th bull signal since the broad markets began to recover from the post-recession crash. Of the 15 prior beakouts, 10 produced a profit, with an average yield of 14.4%. The five unsuccessful trades averaged a 4% loss.

Adjusting the winners' yield by the 66.7% success rate prdoocues a score of 9.6%, nearly double my preferred minimum of 5%.

The bull signal comes amid a longer term uptrend that began in early September 2011 from $15.08. It has stair-stepped higher to its trend peak, $38, which it touched today. The most recent major correction began in early October 2012 from $37.85 and carried the price down to a low of $29.84 on Dec. 28.

In the present leg up from last December, GPS has completed three bull signals. Two were successful, with an average yield of 1.9%, compared to a loss of 3.9% for the one losing trade. When the losses exceed the yields, that's a caution signal for traders, even if the majority of the positions earn a profit.

The Gap runs several chains of stores under the corporate name as well as Old Navy and Banana Republic. Altogether it has 3,263 stores, nearly all of them company-owned.

Analysts have reservations about Gap's future performance, giving it a negative 22% enthusiasm rating.

This despite a return on equity of 38% (!!!) with acceptable if not outstanding debt amounting to 43% of equity. My definition of a growth stock begins with 20% return on equity with debt of 10% equity or lower, but perhaps nearly double the minimum return can support the growth-stock label, even with higher debt.

Like most retailers, Gap's earnings are 4tth quarter plus change, and that quarter presents a mixed picture the last couple of years: Down in 2012 from 2011, but higher than either in 2013.

Gap's earnings have risen from one quarter to the next in each of the past six quarters.

Institutions own 53% of GPS shares and the price in near sales parity. It takes $1.11 in shares to control a dollar in sales.

GPS on average trades 3.3 million shares a day, providing sufficient liquidity to support a good selection of option strike prices with open interest running to three and four figures. The front-month at-the-money bid/ask spread on calls is low, at 2.5%.

Implied volatility stands at 33%, just below the middle of the six-month range. Volatility has been drifting upward since early March.

In the analysis that follows, I refer in several places to "68.2%". In statistics, this represents one standard deviation from the mean, a tool that sets boundaries that are expected to encompass 68.2% of whatever is being studied, such as public opinions or stock trades.

Options are pricing in confidence that 68.2% of GPS trades will fall between $34.33 and $41.47 over the next month, for a potential gain or loss of 9.4%, and between $36.19 and $39.61 over the next week.

The fair-price zone on today's 30-minute chart runs from $37.75 and $38.01, encompassing 68.2% of transactions surrounding the most-traded price, $37.88. The price spiked sharply in the first hour of trading but subsequently has tracked near the most-traded price. (I'm writing with 90 minutes left before the closing bell.)

Gap next publishes earnings on May 15. The stock goes ex-dividend in July for a quarterly payout yielding 1.58% annualized at today's prices.

Decision for my account: Actually, I already have a bull position in GPS left over from the last breakout. 

Part of the position was closed, and the remainder is structured as short vertical spreads expiring April 20. At the present price they will expire worthless, allowing me to keep the premium I received when I sold the spread.

(You can read about the position, opened in early March, here.)

So opening a new position to accommodate Wednesday's bull signal is more like rolling an existing position. I have opened an additional position, structuring it as a short vertical spread expiring May 18. 

The spread is short the $36 put and long the $34 put.  The position provides a 4.8% cushion where it remains profitable below the entry prices. The maximum potential yield is 17%.


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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