SBUX: Bull-Bear tag team

Update 7/24/2013: SBUX pierced the lower boundary of it's 10-day price channel, bringing this bear position to a close. Actually, the position was closed July 10 with the intent to roll when it broke above its 20-day price channel. It did break out on July 5, confirmed on July 6, but I failed to make the trade amid preparations for an overseas trip. 

Sometimes trading errors are fortuitous blessings. From the missed roll's breakout level, SBUX rose 3.3% in six trading days, and then began the decline that triggered the close signal at $67.45, a 0.3% loss unhedged and a bigger one with the hedged position I would have opened.

SBUX shares lost 0.2% during the average of 17 days I held the position. I structured the position as short vertical spreads. The options produced a 31.1% profit.

Starbucks Corp. (SBUX) was among nine positions that I exited on Friday under my rules. The price had closed below the 10-day price channel on Wednesday. (See "How I exit hedged positions" for details of how I handle such things.)

The exit produced a 3.3% gain on the share price and a 16.% gain on my hedged position, which was built from vertical option spreads sold for credit.

I've long said that I have no idea which way the market will move, and SBUX acknowledged the accuracy of that sentiment by closing on Friday above the 20-day price channel, sending a bull signal that was confirmed in trading today.

I mean, two days after an exit signal got me out, SBUX roared bag with an entry signal to the upside. It's a classic Bull/Bear tag team straight out of the American pro wrestling circuit.

If I open a new position, it essentially will convert Friday's exit into a roll of the position that was executed a week earlier than anticipated.

But let's not rush in. The questions I have to ask are, Do I still like SBUX as a bull play? And do I treat it as a roll or as a new bull play? The answer to the latter determines how many units -- options spreads in this case -- should I buy upon entry. If it is a new bull play, the answer is one. If a roll, the answer is four, since I was fully invested under my rules.

SBUX has been in an uptrend since -- well, really big picture, since 1995. The massive price collapse of 2006-2008 ended above the previous major correction low, keeping the trend intact. 

The most recent leg up began in August 2012, and since then SBUX has broken out to the upside four times. The three completed bull signals were all profitable, an average yield of 5.4% on trades that, on average, lasted 55 days before concluding with an exit signal.

Today's breakout  carried the price to a new all-time high of (so far) $66.29.

SBUX was one of seven symbols that survived my initial screening after Friday's session. (See my weekend post "Monday's Prospects" for details.) Of those seven, three failed confirmation today by retreating back within their price channels: GPS, BEAV and SAM. 

Of those remaining, AMZN has had no profitable breakouts to the upside within its current trend, COO has insufficient open interest on options to meet my criteria, and XEC's breakout to the upside runs counter to its present downtrend.

Analysts have sufficient love for SBUX to give it a 32% enthusiasm rating, and like most love in the markets, their's is based on a proven ability to make money. Starbucks reports return on equity of 28% with low debt amounting to 10% of equity. This makes SBUX a growth stock by my definition.

As I look at the last 12 quarters, I find that Starbucks has been profitable in each. The peak profit quarter each year is the 1st, and that quarter in 2013 was higher than its year-ago counterpart, and the same is true for 2012. Earnings have surprised to the upside 10 times and to the downside, twice.

Institutions own 72% of shares -- a bit on the lowside for such a dynamic, big-name brand -- and the price has been bid up to a high level. It takes $3.47 in shares to control a dollar in sales.

SBUX on average trades 4.7 million shares a day, sufficient to support a fine selection of option strike prices with open interest in the four figures. The front-month, at-the-money bid/ask spread on calls is quite narrow, a 1.2%.

Implied volatility stands at 23%, in the lower half of the six-month range. It has been stair-stepping in a shallow uptrend since mid-May.

Options are pricing in confidence that 68.2% of trades will fall between $61.68 and $70.60 over the month, for a possible gain or loss of 6.8%, and between $64 and $68.28 over the next week.

Trading in options today is running at a rapid clip, with call volume running triple the five-day average, and put volume at twice the average.

The fair-price zone on today's 30-minute chart runs from $65.61 to $66.07, encompassing 68.2% of transactions surrounding the most-traded price, $65.89. SBUX opened at the bottom of the zone and moved decisively above it in the third hour of trading.

Starbucks next publishes earnings on July 25. The stock goes ex-dividend in August for a quarterly payout yielding 1.27% annualized at current prices.

Decision for my account: I have opened a bull position in SBUX, structuring it as vertical option spreads expiring in July, sold for net credit, short the $65 put and long the $62.50 put. This structure will produce a profit at expiration even if the stock falls by 2.9%, and it has a potential maximum yield at expiration of 21%.

I decided to treat the entry as a new trade of one unit rather than a roll of four units (see graf 6 above for a discussion of what that means). SBUX did, after all, fall below the 10-day price channel, sending an exit signal under my rules. If I'm not a strict constructionist about such things, then the rules have no meaning, and my trading will descend to the level described by Alexander Pope:

Thy hand, great Anarch! lets the curtain fall,

And universal darkness buries all.

-- The Dunciad (1728)

References

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

At several points in my analysis I use the number 68.2%. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

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.