A Strangling at Starbucks

Starbucks, $SBUX, has technically been a very interesting stock of late. The chart below shows that from a high in April it fell to a low in August before rebounding. The bounce ran right into the corner of the 50% Fibonacci retracement and the Fibonacci Arc before rising the Arc lower. On consolidating through the Arc it then jumped to the next Arc and over the 38.2% Fibonacci level after releasing earnings. Still with me? Now is where it gets interesting. Bouncing between the 50% and 38.2% Fibonacci, or roughly between 50 and 52.50 it is setting up for a move. The Relative Strength Index is bullish and the Moving Average Convergence Divergence indicator (MACD) is positive, supporting an up side break. But both are fading and there is now a large gap to fill below. What to do? Play it both ways. The swing stock trader would wait for a break above 52.50 to enter long or below 50 to enter short. But by using the options market we do not have to wait. Looking at

the options chain, implied volatility is relatively low and flat at near 25% for all strikes, compared to the historical volatility of 33%. This is a good time to buy options. Since we want to play it both ways we will look at a Strangle, buying both a put and a call. In this case the December 50/52.5 Strangle, buying the December 52.50 Call and the December 50 Put costs $2.29 as of late Monday. The stock would need to move beyond the range 47.71 to 54.79 by December Expiry to profit. A gap fill lower would certainly do this, as would a break of resistance from the highs in May and June. You can improve your odds by turning it into an Iron Condor. This is just a fancy name for turning the trade into two Spreads, A Call Spread and a Put Spread. by selling both the December 55 Call and the December 47 Put, the cost of the structure drops to $1.46 and the trade becomes profitable when the price moves outside of the range 48.54 to 53.96. But it also caps the upside at a price of 55 if it rises and 47 if it falls. Still a potential 71% return at 55 and 105% return at 47 is not too shabby.

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Dragonfly Capital Views Performance Through October 2012 Expiry

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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