The reaction to Starbucks Corporation’s (NASDAQ:SBUX) earnings was the craziest I’ve seen in a while. Starbucks delivered what I thought was less-than-ideal report, yet SBUX stock spiked 5%! I have to say, I was a bit disappointed. I look to profit from quality stocks on bad days, and I was waiting for an opportunity with Starbucks stock.
Minutes later, the company CFO spoke and made my dream come true: SBUX went from +5% to -7% in after hours. My opportunity had arrived.
I said I like to profit from dips in quality stocks, but that doesn’t mean that I buy their stocks. Instead, I use options to set up my trades … but I don’t buy those either. I sell options against what other people fear, as long as I see value in the underlying stocks. I collect a premium for doing so, and time does the rest. If price stays above my strikes then the premium expires worthless in my favor.
Starbucks is a proven performer with a solid base of clients who are literally addicted to the product.
SBUX Stock Fundamentals
Fundamentally, it’s not cheap with a 30 price-earnings ratio, but not all great companies sell at a discount. Some like SBUX historically carry higher valuation and nothing I read in this report changes its metrics for me.
This is not the same as saying that it’s a bloated stock. However, I do have to recognize risks especially when the equity markets in general are near all-time highs and seemingly overdone. SBUX pays a dividend, which usually helps support stock in market downturns.
I read once that Warren Buffett, who is considered the guru of investing, likes to own companies who have a guaranteed base of revenues upon which they can build growth. In this case, Wall Street’s beef with the company is that it has too many people at the checkout line.
Customer throughput is a sign of strength. That to me is what Buffett would cheer for. Operational issues aside, the base case for this stock is rock solid and that’s the kind of risk I like to bank on.
Then there is the social aspect. In this digital age where we are glued to our smart phones, SBUX is a daily human interaction. I know we love our phones, but I also know that we also love the daily habit of getting “the usual” from a barista. It’s an experience that we’d miss so we’re not likely to give it up anytime soon.
You get the idea … I like the company and the the trick becomes choosing smart entry points. Big red days without a long-term cause are usually good ones. This is especially true since SBUX stock was already 10% lower than its recent highs, so with this dip here it’s going to be a real bargain.
I am used to seeing the stock trade in waves. These are not scientific, but they show that Wall Street falls in and out of love with Starbucks stock for extended periods at a time.
My using options I build myself buffers between the risk and current price thereby alleviating the need to be absolutely perfect in my timing.
The Bet: Sell the June 2018 SBUX $45 put for $1.10 per contract. This bullish trade has a 90% chance of success. If price stays above my strike then I keep the whole premium for maximum gains. Otherwise, I suffer losses below $ 43.9.
Not all investors are willing to accept the risk all the way down to zero. For those I can sell spreads instead where I buy an equal number of puts lower than the ones that I sell. So the maximum risk would then be much smaller and so will be the margin required to open the trade.
The Alternate Bet: Sell June 2018 SBUX $45/$40 credit put spread which has the the same odds of success and can potentially yield 12%. Compare this with needing to risk catching this falling knife at face value here and without any room for error expect a rebound.
Selling options is risky business, so never risk more than you are willing to lose.
Learn how to generate income from options here. 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.
