Investors are awaiting the results of the first set of stress tests among 38 of the US’s top financial institutions. They are expecting large returns of capital to the shareholders after the release of this report. Gains in financial shares may be muted. Many of these financial companies undergoing the test are expected to boost dividends and share buybacks as a result of higher profits on the back of tax cuts and rising net interest income.
The market continues to exhibit weakness across the board. Let’s consider Starbucks (ticker: SBUX)
If one was strictly a stock trader, selling (shorting) SBUX in the $51.25 area could be prudent. You are anticipating a move to the downside. As a protective measure, it is always good practice to place a buy-stop order. In this case, placing that order in the $55.00 area will mitigate potential losses.
For active traders with a shorter investment time horizon, you can consider a setup utilizing options. Given the market conditions outlined above, taking an active, premium debit approach may be the best path to success.
Because of the reasons given above, the purchase of a debit put spread may be one way to approach this situation. The first order of business is to calculate your target strike. In order to perform this calculation you need three pieces of data: last trade price, options expiration date and implied volatility for that expiration date. This calculation for SBUX yields a target price of approximately $50.00. You may want to consider the SBUX July 6th weekly expiration 50/51 puts spread, buying it for $0.30. The most you can lose is the debit paid and the most you can profit is the width of the spread less any premium paid. Max risk = $0.30 and max reward = $0.70. This means that you are getting odds of 2.33:1.
Given the trading and market environment outlined above, a trader must evaluate whether this reward/risk ratio is appropriate for his/her risk tolerance.