A Second Chance To Buy This Popular Stock

Friday, May 8, 2015 - 7:30am

by Michael Kahn

Although it may sound cliche, the trend truly is your friend. Throughout this bull market, stocks in rising trends have continued to rise and stocks in falling trends continued to fall. We can see this stark contrast in two coffee stocks. 

Last month, Starbucks (NASDAQ: SBUX) gapped up 4% the morning after its strong fiscal second-quarter earnings. Keurig Green Mountain (NASDAQ: GMCR) missed estimates Thursday and gapped down nearly 12% on the day's open.

The difference was the prevailing trend for each stock. Starbucks was rising nicely while Green Mountain was in a bear market.

Before I get to today's trade, I want to call out a great trade made by my colleague, Jared Levy. Earlier this year, he capitalized on GMCR's downtrend with a put option trade that only cost $2,390 and returned 34% in just 56 days on an 11% drop in the stock. That's a 221% annualized return.

Options are the best way to amplify your returns on any stock move -- up or down. And at the end of this article, Jared will provide you with an option trade that could turn an 11% move up in SBUX into 150% profits in just over two months, as well as an opportunity to sign up for his weekly trade recommendations.

Investors who didn't spot the resistance breakout in SBUX on April 23 before the earnings announcement were not likely on board when shares jumped right after the news came out after the bell. But as is sometimes the case, stocks give buyers a second chance to get in at better prices. 

As of this week, Starbucks eased all the way back to its April 23 breakout level. 

SBUX Stock Chart

The question is whether this is a correction in a bullish trend or the end of the road for that trend. There are several reasons why I believe it's the former.

First, the trend itself is still up. Prices remain above the 50-day moving average, which serves as a proxy for the trend. I do not use it as a trade trigger, but in the absence of a robust trendline, it is a good guide to the stock's mood. That mood is good.

Second, Starbucks is still outperforming the market. Both absolute and relative performance charts are rising.

Next, momentum remains solid. An indicator such as the Relative Strength Index (RSI) maintained highs near 80 and lows near 50. Normally, we think of 80 as overbought and 20 as oversold, but trending stocks do not conform to that one-size-fits-all approach. Strong stocks usually do not see RSI dip to 40, so SBUX is "beating" on this metric, as well. Bulls are jumping in before letting prices drop too low, and that suggests demand is strong.

Finally, sentiment remains bullish. For a read on investor sentiment, I like to look at social media site StockTwits. This site is frequented by professionals and very active individual traders, so unlike more mainstream media sites, I find they usually get it right. 

If, for example, the network evening news were to tout Starbucks' stock, I would run the other way. When the mainstream latches on to an idea, it is often too late. This is the essence of the magazine cover indicator. I will leave it to the reader to investigate that phenomenon further, but StockTwits currently shows an 84% bullish rating for SBUX.

Also on the sentiment front, the controversial "Race Together" campaign where customers were encouraged to have a discussion on race relations did not do any damage to the stock. Investors did not care one way or the other for the company's known social conscience. 

As we can see in the chart, prices came down to test the breakout level at just under $49. Volume was not a perfect complement, but it did display a general contraction since the big rally last month. It at least does not suggest any urgent selling, so I'll take it as a positive sign.

With Thursday's apparent upside market reversal, Starbucks looks ripe to end its slide. A move over Wednesday's high at $49.70 would be the buy signal and tell us the rising trend has resumed. 

Acknowledging that the long-term trend has been in effect for several years and the short-term trend has accelerated, I do not want to be too aggressive with an upside target. A new high in the $55 area is a reasonable first objective as it follows the rising trend channel from the January gap up breakout. However, this is a trend-following trade, so I would not be surprised to see it continue higher from there. 
 
Recommended Trade Setup:

-- Buy SBUX above $49.70
-- Set stop-loss at $47.50
-- Set initial price target at $55 for a potential 11% gain in six weeks

Amplify Your Gains: Generate 150% From an 11% Stock Move

You could amplify SBUX's potential 11% move into a 150% gain by buying SBUX Jul 47.50 Calls at $3 or less.

The trade breaks even at $50.70 ($47.50 strike price plus $3 options premium), which is 3% above current prices.

If SBUX hits Michael's upside target of $55, then the call options will be worth at least $7.50 ($55 stock price minus $47.50 strike price). Once you enter the trade, place a good 'til cancelled (GTC) order to sell your calls at that price.

Profit Amplifying Trade Setup:

-- Buy SBUX Jul 47.50 Calls at $3 or less
-- Set stop-loss at $0.80
-- Set price target at $7.50 for a potential 150% gain in 71 days

If you're interested in learning more about options or getting trades like this sent to your inbox each week, follow this link.

This article was originally published on ProfitableTrading.com: A Second Chance to Buy This Popular Stock's Breakout​

Michael Kahn does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.