by Enis July 27, 2012 2:52 pm • Commentary

Here’s a preview of what I’ll be discussing tonight on Options Action at 5:00 pm EDT on CNBC:

Let me first say that the trade idea I’m proposing today is a very low conviction trade, but it’s an intriguing situation that makes for a good TV story, so I looked for a good risk/reward way to play GMCR earnings next week.  I did this trade in very small size, the smallest size I’ve used for any trade on the site, and would not recommend this beyond extreme speculation.

Green Mountain Coffee Roasters (GMCR) has been on an incredible roller coaster in the past 5 years.  Here is the 5 year weekly chart:



The stock has gone from $5 to $115, and almost all the way back down, trading around $18 today.  I wrote about GMCR in a previous trade from June where I actually sold a put spread as a way to initiate a bullish bet.  I took that trade off earlier this month for a small gain, and the stock has since hit new lows again.

Back then, I made the argument that GMCR was a stock getting crushed because of forced selling by the founder, and the technical setup along with the high implied volatility made for a good entry on a short put spread.  The valuation also seemed cheap at 8.5x earnings, which I thought should afford downside protection.

However, the story seems to have gotten worse in the past couple months.  3 broad points working against GMCR:

  1. Increased competition from Starbucks and others, coinciding with patent expiry in September.  The K-Cup business is going to get more crowded, and for a company with growth concerns in the first place, competition might be formidable
  2. Management has made numerous missteps in the past 2 years.  Accounting irregularities and inventory shenanigans are usually not mistakes made on their own.
  3. There are reports of price reductions by GMCR to move their inventory.
The implied move is 20% vs. the 8 qtr historical average of 22.4%, so volatility is very high, and the market is expecting a big move either way here.  Like I said, I don’t have much conviction, but I initiated the following trade in very small size:
TRADE: GMCR ($17.90) Bought the Dec 14 / 7 1×2 put spread for $1.30
  • Bought 1 of the Dec 14 put at 1.76
  • Sold 2 of the Dec 7 put at 0.23 for a total of .46

Break-Even on September expiration:

  • Profits between 12.70 and 1.30, max profit of $5.70 with stock at 7 on expiry.
  • Losses between 12.70 and 14.00 and 1.30 and 0, with a max loss of your premium of 1.30
Trade Rationale:  I want to reiterate that I put this on in small size with low conviction.  However, in broken story situations like this, there are times where the stock just never finds its former glory.  See RIMM, see NFLX, see GRPN or ZNGA as examples.  GMCR is a much different company, but this trade gives me 4 months to see if GMCR is indeed a broken story, or just a battered stock.