Name That Trade $GM: Detroit Rock City

by Dan March 5, 2014 10:33 am • Commentary

Last night on CNBC’s Mad Money I was flattered to have Jim Cramer highlight our technical work on GM – watch here:

We have had a bullish view on GM since late last year, but the stock has seriously lagged its major peer Ford and the broad market.

Monday’s February auto sales data might have pointed to a bit of a sentiment shift as GM’s results were far better than analysts had feared (down 1% year over year vs down 7.7% estimate) while Ford’s was worse than expected and had the company ceding about 2% market share in the period.

Back in early December, after the Government’s exit of its bailout stake, we highlighted hedge fund manager Hayman Capital founder Kyle Bass’ very public and very bullish fundamental thesis as we introduced our own bullish trade structure:

From per Hayman Capital presentation dated 12/4/13

As far as the near term catalysts that Bass pointed to at the time, many have already come to pass, like govt exit of stake, re-initiation of dividend and share buyback, and the inclusion to the S&P 500.

So let’s quickly hit the charts.  The one year chart below shows the downside support and the upside resistance, with the stock basically right in between:  

[caption id="attachment_37101" align="aligncenter" width="589"]GM 1yr chart from Bloomberg GM 1yr chart from Bloomberg[/caption]
In the near term, the stock needs to hold this $34-$36 area, where it has spent some time consolidating over the past month, while the broad market marched to new highs.  A break below $34 on news would likely see a re-test of the June lows around $31.
On the upside, the stock could see some intermediate term resistance just above the 50 day moving average at $38.45 and the breakdown level from January at $39.  If the stock can get through there, the next target would be the previous all time high just below $42.

While the stock’s poor relative performance is cause for concern, it is my sense that the poor sentiment towards the stock in 2014 could be one of the main reasons why the risk reward is skewed to the upside with the slightest bit of good news.  Just as a string of disappointments weighed on the stock, a reversal of such fortunes could cause the sort of reversion trade back to the previous resistance.  A good deal of bad news may be “IN” the stock.

Also, Enis has whipped up a fairly interesting chart showing the correlation of GM’s stock performance with that of the yield of the 10 year Treasury over the last three years – GM (red) vs. the 10 year yield (green):

[caption id="attachment_37102" align="aligncenter" width="619"]GM vs 10 year Treasury Yield from Bloomberg GM vs 10 year Treasury Yield from Bloomberg[/caption]

The crucial levels to watch on the 10 year yield is 2.50% on the downside, and 3.00% on the upside.

One last point, implied volatility is relatively cheap, getting neared the lower end of the last 2 years.  The chart below shows the 30 day at the money IV for the last 2 years (blue line) vs the 15 day realized vol (white line). The realized shows just how much the options have actually been moving, and in this case it is apparent far less than the options are implying, which is why I suggest they are relatively cheap:

[caption id="attachment_37103" align="aligncenter" width="589"]GM 30 day at the money implied vol vs 15 day realized vol from Bloomberg GM 30 day at the money implied vol vs 15 day realized vol from Bloomberg[/caption]

We have what was an in the money call butterfly that will likely expire worthless on March expiration, but we now want to roll this bullish thesis out and down with structure that defines our risk to the key support level below, while allowing for appreciation up to the targeted near term technical resistance, but allowing for profits up to the prior highs.  With the stock up 2.5% today, I am not going to chase it, but I am going to lay out the trade that we want to do if the stock were to come in a bit back towards $37 in the near term:

Hypothetical Trade: GM ($37.85) Buy April 37/40/43 Call Butterfly for .85

-Bought 1 GM Apr 37 call for 1.60

-Sold 2 GM Apr 40 calls at .42 each or .84 total

-Bought 1 GM Apr 43 call for .09

Break-Even on April Expiration:

Profits: between 37.85 and 42.15 make up to 2.15 with max gain of 2.15 at 40

Losses: losses of up to .85 btwn 37.85 and 37 and btwn 42.15 and 43, max loss of .85 below 37 and above 43

Rationale:  This structure is a great alternative to buying the stock here as it provides some room to the downside on break-evens while having a realistic upside sweet spot at $39. This trade will do quite well on a slow move higher and won’t lose a ton of value if the timing is slightly off and the stock comes in a little.