Last week investors took to Sprouts Farmers Market Inc (NYSE:SFM) like we’d expect a child might react to eating a plate of brussels sprouts — the company’s earnings were a disappointment.
Far from all bad though and as a child might eventually appreciate; the foul-tasting dismissal smells like fresh opportunity for bullish option traders.
Looking at the report and the anxiety behind SFM stock’s bagging, the Phoenix-based organic grocer missed Street profit estimates by 2 cents in coming up with earnings of 25 cents a share, while sales fell short by $12.5 million on revenues of $857.5 million.
On the other hand, the reaction in shares of SFM seems an overreaction when one considers a couple other items left behind at the checkout counter. First, despite the misses, Sprouts did manage to report a year-over-year profit increase of 11%. What’s more, Sprouts also grew its revenues by 19% from the year-ago period.
At the same time, far from any dire warnings by SFM, the company said it plans to open 27 additional stores in 2015 and anticipates full-year sales to grow by 20% to 22%.
SFM Weekly Chart
A year ago in May, some very similar deep and well-planted behavior by investors in SFM resulted in an all-time-low in shares of $25.73 being established. From there, shares of SFM bloomed to produce gains of about 50% by late February this year. Is another harvest on the horizon?
Technically, we see Friday’s price bagging of about 10% in SFM stock as the icing on the cake for bulls waiting for a playable pullback — cake I’m sure that’s organically baked. Speaking of baking things right, the total correction thus far from the February highs is a tad under 30%.
Corrections in the 30% to 35% neighborhood are considered by many traders as part of the rite of passage for up-and-comers like Sprouts Farmers Market and price action now manifested in shares of SFM. Just ask competitor and the older kid on the block, Whole Foods Market, Inc. (NYSE: WFM) about the sometimes difficult shortcomings of failing to feed the Street’s growth expectations its endured during its time as a publicly-traded company. Better yet, just look at a historical chart.
Along with Friday’s price decline SFM experienced strong capitulation volume of more than 11 million shares. That’s the most in Sprouts Farmers Market stock’s trading history and compares to an average daily volume of around 2 million shares.
As well, the fierce drop managed to put shares of SFM outside of both its daily and weekly Bollinger Bands. That type price action hints strongly at an oversold condition, which is also showing up in both period’s Stochastics readings.
Lastly, I like that SFM stock’s technical action has retested the other critical low established in shares back in October during the broader market’s own bout of brussel-sproutitis. This sets up a nice test of the top of a support zone of $25.73 to $27.17 stemming from the aforementioned May 2014 low.
SFM Long Call Strategy
SFM’s volatility chart provided shows implieds are currently below the stock’s statistical movement and cheap theoretically, but shouldn’t be expected to last. The reason is two-fold. First, earnings in SFM are out of the way and option implieds generally get pressured in the aftermath of a report as that type of uncertainty is removed.
Secondly and in this instance, the spike in underlying SFM stock volatility (brown line) is a direct result of Friday’s outsized price shellacking. That of course isn’t a daily phenomenon and more normalized volatility should follow and act as a drag on statistical volatility in the days ahead.
That all said, a visual inspection does suggest limited downside in SFM implieds and makes an outright long call purchase worth consideration for like-minded traders anticipating upside in the months ahead, given what’s been expressed today.
Checking the board with a focus on planting, growing then harvesting profits after a proper allotment of time, the Dec $30 call for $1.55 looks attractively priced on a risk-to-reward basis and gives the trader more than 220 calendar days to expiration.
With slightly less than 40 deltas and given the described support zone, baring a gap a trader could reasonably cut their loss in half over the next month were SFM stock to actual drop below support. And of course, the position can never lose more than $1.55 per contract if in fact an even nastier serving of brussel-sproutitis does set in.
On the upside, SFM shares need to rally about 13.5% to breakeven at $31.55 on an expiration basis. However, any meaningful upside along those lines prior to expiration has the potential to yield much stronger results due to extrinsic or time value in the call contract.
For instance, if SFM claimed that level in the next 60 days, the trader would have roughly a double or better on their hands. And if during the life of the contract, analyst Meredith Adler from Barclays is correct by maintaining its “overweight” rating and finds its share trimming from $42 to $40 is gobbled up, that would work out to a very festive gainer of nearly 550%.
As of this writing, investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon his observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT
