Chipotle’s Flag Hints at Higher Prices

by Tyler Craig | April 30, 2013 6:00 am

Chipotle’s Flag Hints at Higher Prices

Following a better-than-expected earnings announcement on April 19, shares of Chipotle Mexican Grill (NYSE:CMG[1]) soared 11.5%, extending CMG’s year-to-date gains to more than 23%. The ongoing recovery in Chipotle has healed much of the damage done in 2012, when the stock fell as low as $233.

CMGchart 300x233 Chipotles Flag Hints at Higher Prices
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Since the earnings jump from two weeks ago, CMG has spent its time forming a bull flag more tightly wound than a well-folded burrito.

In technical analysis lore, the bull flag is a continuation pattern that develops after a rapid, nearly vertical advance in the stock’s price. The classic tome Technical Analysis of Stock Trends by Robert D. Edwards and John Magee explains the bull flag as “a small, compact parallelogram of price fluctuations, or a tilted rectangle which slopes back moderately against the prevailing trend.” Consider the flag the digestion of gains acquired by the prior advance, which acts as the “pole” upon which the flag flies.

Throughout the flag, volume tends to taper off, reflecting both an absence of aggressive profit-taking and a quiet pause in demand before a new round of bulls take the shares higher. When the stock finally does break out of the consolidation to begin its new advance, it should be accompanied by higher volume.

As with a number of technical formations, the bull flag comes complete with a measuring formula to forecast a price target. Flags are said to fly at “half-mast,” which means the length of the stock’s next advance often is equivalent to its prior advance that formed the flagpole. CMG’s flagpole began when it broke away from $345, which was resistance for a previous consolidation zone. Its subsequent rise lifted the stock to $367, forming a pole with a height of $22. If we add $22 to resistance of the current bull flag ($367), we achieve an upside target of $389.

To exploit the imminent resolution of the flag, you could purchase the June 370-390 bull call spread by buying the 370 call and simultaneously selling the 390 call for $7.30. The max loss is limited to the initial debit paid, or $730. The max gain is limited to the distance between strike minus the net debit, or $12.70.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. CMG: http://markets.financialcontent.com/investplace./quote?Symbol=CMG

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