I recently wrote a trade on Starbucks Corporation (SBUX) stock that went nowhere because the potential never materialized. We can thank a lack of Starbucks-specific headlines and the general malaise weighing down equity markets. But that’s fine — when a trade stalls, just scratch it and start anew!
I am a fan of Starbucks because it’s well-managed, and I think it should do well in the long-term. While 2016 has been challenging, SBUX stock still is up 5% over the past 12 months. My concern here is the general market — namely, that there’s tremendous global risk to growth that traders are ignoring. They’re recklessly buying in the face of deteriorating fundamentals.
Click to Enlarge Equity markets are putting too much faith in the Federal Reserve’s ability to save us. The past two weeks have proven that the Fed is helpless. Consider the “FANGs” — Facebook Inc (FB), Amazon.com, Inc. (AMZN), Netflix, Inc. (NFLX) and Alphabet Inc (GOOG, GOOGL). US Fed Reserves’ ability to save us. Collectively, they’ve breached support trends with considerable downside potential. That’s a problem, because as a group, they can make or break the market.
Technically, SBUX stock is at a pivot point. It also rests at the bottom end of an 18-month ascending trendline.
Under better global circumstances, I would bet on a 5%-plus bounce to $58 per share. But in these conditions, I believe that the general markets will fall, thereby causing Starbucks stock to eventually breach the trend to the downside.
Click to Enlarge I don’t anticipate a complete breakdown in SBUX stock, but I do want to capture this swoon. Here, I like medium-term dated puts. The magnitude of Starbucks’ past three corrections were identical, and I’ve marked them with the vertical yellow arcs on the chart. This gives me a level to target.
The drop seems drastic but not impossible; we’ve seen SBUX fall 10% twice this year.
I usually don’t like to risk much out-of-pocket, so we’ll set up a pair trade. First, we’ll capture the bearish move, then we’ll completely eliminate out-of-pocket risk by collecting premium from a second bullish trade.
Trade #1 – The short: Buy the SBUX Oct $55/$52.5 debit put spread (a bearish trade) for 87 cents per contract. This is my maximum potential loss. I stand to more than double my money if SBUX stock falls through both legs in the next 124 days.
Trade #2 – The bank: Sell the SBUX Jan $43.75 puts. This is a bullish trade for which I collect $1 per contract. I only sell naked puts if I am able and willing to own Starbucks stock at my strike price. In this case, if Starbucks falls through $43.75 per share this year, I could be put the stock. So I would own SBUX stock at a 20% discount from current levels.
Ideally, I need SBUX to fall to about $50 before mid-October. Then I need it to bounce above $43.75 per share through January. Even if Starbucks holds up and I fail to capture any of the downside profits, I would be left with a net credit into my account from this pair trade.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
