Bear market rallies can be cruel traps. We are not suggesting we are in a bear market just yet, but as we have been saying for months, the path of least resistance is no longer higher, and most major equity market indices the world over are in sharp downtrends from 52 week and multi-year highs. This morning’s opening is a little give-back from late last week. Our markets were weak while China’s were closed. China didn’t crash following their long weekend and so US equities are having a bit of a relief rally today.
But we still expect to see some large cap, crowded stocks that got absolutely creamed during the panic on August 24th re-test those levels in the coming weeks. As we described in our post from Friday (here) and as Dan discussed Friday on CNBC’s Options Action we like the idea of targeting Starbucks (SBUX) on a bounce:
Today we got the bounce. So here’s the trade:
Trade: SBUX ($54.80) Bought Oct 52.50/47.50 Put Spread for .85
-Bought to open 1 Oct 52.50 put for 1.25
-Sold to open 1 Oct 47.50 put at .40
Break-Even on Oct Expiration:
Profits: up to 4.15 between 51.65 and 47.50, max gain of 4.15 below 47.50
Losses: up to .85 between 51.65 and 52.50, max loss of .85 above 52.50
Rationale: This spread is out of the money, and options prices are high, so in any other market environment this would be the exact sort of options trade we would avoid. But we feel strongly that a re-test of the lows from two weeks ago in the S&P 500 could cause another panic in crowded trades like SBUX. Given the way the broad market is moving this trade could be at the money very soon, but we will cut our losses to 50% of the premium at risk if the stock continues higher from here.