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Identifying underperforming stocks is becoming a challenge, with the broader market approaching new highs. Starbucks (SBUX) looks like it could be an interesting stock to bet against. While the stock saw an impressive 18% surge post an earnings beat at the start of the month, it’s displaying indications of fatigue, signaling a potential pullback. SBUX 6M mountain Starbucks, 6 months To confirm a bearish bias on SBUX, I am using two technical indicators in the chart below: RSI (Relative Strength Index): Understanding the RSI indicator is fairly straightforward. If it moves above 70 it means the stock is overbought, if it drops below 30 the stock is oversold. While being overbought doesn’t guarantee a reversal, a drop below the 70 mark after being overbought often signals a potential pullback. In the chart below, RSI was overbought as it was above the 70 line from Nov. 2 to Nov. 16. It has dropped below 70 and is trending downward indicating a potential reversal. DMI (Directional Movement Index): When the DI+ (green line) is above DI- (red line), the stock is in an uptrend. However, when the DI lines start changing direction, that indicates a possible change in the current trend. This is exactly what we are seeing in the chart below. A bear put spread With a bearish directional bias in place, all I need to do is find a suitable options structure to take a bearish trade. The trade structure I am going to use here is called a “bear put spread” also known as a “put debit spread.” If you look at the SBUX option chain, you will notice that this is a highly liquid stock with $1 wide strikes. This is great, because you can construct a $1 wide put spread and risk as little as $50 to make $50 per winning trade. To increase risk, simply add more contracts. Eg. Doing a 50 contract trade would risk $2500 to make $2500. SBUX is currently trading around $104.30 If by expiration, SBUX drops to $104 or below, my put spread will be able to yield a 100% ROI. Here is my exact trade setup: Buy $105 put, Dec. 15 expiry Sell $104 put, Dec. 15 expiry Cost: 50 cents A nice thing about buying ATM (at-the-money) spreads, is that the math becomes very easy. ATM spreads can usually be bought for half of the width of the strikes. Since the width of our spread is $105 – $104 = $1, I can buy the spread for 50 cents. Profit target: If SBUX is trading at $104 or below on expiration date, this trade will double my money. Managing losses: A very important part of any profitable trading system is that it needs to have positive expectancy. That means the winners need to add up to more than the losers. For me to create positive expectancy with this trading strategy, I will close this trade if I lose 50% of my investment (i.e 25 cents). By simply doing this, every winner will cancel out two losing trades. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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