Options Update: Starbucks Calls Popular Despite Brewing Economic Trouble

More trouble hit the Street for beleaguered coffee barista Starbucks
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this morning.

The company’s Chief Financial Officer Troy Alstead said that the company faces deteriorating same-store sales and that it will not meet Wall Street’s first-quarter earnings expectations. However, Alstead indicated that SBUX has found another $200 million in savings on top of the previously announced $200 million in cost cuts.

“The holiday season is a very tough environment,” Alstead stated. “I suspect that calendar 2009 will be tougher than it’s been in the last six months,” he continued, but added that now is “not the time to throw the baby out with the bathwater and say we need to shift our strategy.”

Options speculators apparently believe that the company is finally starting to come around, as the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.40 indicates that calls more than double puts among near-term options. Furthermore, this ratio ranks below 88% of all those taken during the past year. Looking at our Intraday Volume Explosion List, it would seem that speculative options traders are pushing this bullish sentiment even further, as more than 30,000 calls have changed hands on the security so far. This wealth of activity has easily outpaced SBUX’s average daily call volume by more than 6 to 1.

The most active contract is the December 10 call, which has seen more than 20,000 contracts trade on open interest of just 3,833. With volume far exceeding open interest, it is likely that we are looking at buy-to-open activity on SBUX. Furthermore, the fact that nearly all of the December 11 calls changed hands at the ask price provides additional support for this supposition.

Starbucks option volume details

The Anatomy of an Starbucks Call Position

Digging into this call activity, I noticed that 2 blocks totaling 2,849 contracts changed hands at 12:02 p.m. Eastern time on the same exchange for the ask price of $0.20. The total outlay for this position would be $56,980 — ($0.20 * 100)*2,849 = $56,980. For this trade to reach breakeven, SBUX would need to rally about 18% to $10.20 per share from yesterday’s close at $8.64 before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $56,980.

By entering this trade, the investor is indicating that he expects SBUX to rally sharply during the next several weeks. The shares are off to a decent start, rising more than 3% so far today, but let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

From a technical standpoint, the cards appear stacked against a SBUX December 10 call. The shares have dropped more than 57% so far this year, finding steady pressure from their 10-week and 20-week moving averages. Furthermore, the former of these intermediate-term trendlines is quickly descending into the 10 region, and could prevent a December 10 call from trading in the money. From a short-term perspective, the 9-9.50 region has contained all SBUX rallies since November 13, placing another layer of overhead resistance between the trader and a profitable December 10 call.

Weekly chart of Starbucks since September 2006 with 10-week and 20-week moving averages

The Sentiment Drivers

With the exception of the options crowd, the rest of SBUX investors are heavily negative toward the shares. Short sellers hold more than 4% of the equity’s float in thrall, and have taken steps to increase their holdings in recent weeks. Specifically, the number of SBUX shares sold short jumped by 24.4% during the most recent reporting period, indicating that the stock could come under additional selling pressure.

Meanwhile, Wall Street is bearishly aligned on SBUX. According to Zacks.com, 8 of the 11 analysts following the shares rate them a “hold,” though none have doled out “sell” ratings on the security. I find this latter fact a bit disturbing, as it leaves room for the situation to grow more negative for SBUX. Naturally, downgrades from the brokerage bunch could extend the stock’s long-term decline.

Sentiment indicators for Starbucks

The Verdict?

While bearish sentiment toward an outperforming stock gives the impression of sideline money that could flow into the equity, bearish sentiment toward an underperforming issue is par for the course. In SBUX’s case, there are still those investors that have yet to fully accept the stock’s poor technical performance. Should these bulls become disillusioned, it could represent additional selling activity for the security.

With this in mind, I would have a hard time entering a December 10 call. In fact, traders might want to consider a December 10 put, which currently sports an ask price of $1.31. For such a trade to reach break even, SBUX would need to fall less than 3% from its current trading range just below $9 per share, as opposed to the roughly 14% move needed for a December 10 call to reach break even.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.