Considering Our Options – $BBY

Considering Our Options, July 10th, 2013: I received several questions in the last week about my view of the BBY position as it rallied towards $30. I was certainly surprised to see it break out so far above the $28-$28.50 area that I expected to act as resistance. However, I also did not take the position off since the risk/reward of taking the spread off when the stock was around $30 was not favorable.

The stock is selling off hard today, back to the prior resistance area, on a negative note by Cleveland Research.

My main thesis on BBY has been technical rather than fundamental, since my trades have generally been short-term. I’ve had some success fading the overbought conditions in the stock. But I wouldn’t be playing the name from the short side if I didn’t think there were some potential fundamental issues as well. Namely, I think the stock’s valuation proposition has changed dramatically vs. the start of the year, when it was trading at half its current value.

In any case, I am going to leave this position on for now. The key level to watch is around $28, which is where the 20 day moving average and prior support comes into play. If it closes below there in the next couple days, I will likely leave the position. If not, I will likely close it out and take the loss.

Original Trade, June 5th, 2013:

I have had some success trading BBY this year counter to the uptrend (trades here and here), which has been a bit lucky given how incredibly strong the stock has traded. But I have found it to be a very technically driven name, and have an easier time figuring when buyers have become exhausted rather than when a new wave of buying is going to occur.

In that vein, it looks like the exhaustion point may have arrived on Monday, when BBY was upgraded (albeit by Suntrust Robinson), and the stock opened at 28.37, and proceeded to close a dollar lower on the day. Since then, the stock has been much ado about nothing, despite the market’s broader weakness, but I think it has some likely catch up to do on the downside, especially given the 1 year chart of decreasing momentum on each push higher:

1 year daily chart of BBY (50 day ma in pink), RSI lower panel, Courtesy of Bloomberg

The lower panel is the RSI, and I’ve drawn an arrow to show that the peak in RSI momentum was in March, but each push higher since then has resulted in lower and lower momentum. A move back down to at least the 50 day would make sense given that multi-month divergence, especially since the run so far this year has been so strong (up $15).

But the structure of the options trade is crucial in a name like this. Here is my trade:

TRADE: BBY ($27.20) Sold the July 26 / 28 Call Spread at $0.99

-Sold 1 July 26 Call at 2.13

-Bought 1 July 28 Call for 1.14

Break-Even on July Expiration:

Profits: Up to 0.99 between 26 and 26.99, max profit of 0.99 at 26 or below

Losses: Up to 1.01 btwn 26.99 and 28, max loss of 1.01 at 28 or above

Trade Rationale: As per my previous two trades, I don’t expect a major fall in BBY given the strong volume accumulation on moves higher this year, and implied volatility is quite high, so I’m wary of paying out premium on a name like this. As a result, I chose to sell a call spread instead, and will look to take it off in the $25 area in the ideal scenario of a pullback to the 50 day ma.