GMCR is Vulnerable

Green Mountain Coffee Roasters Inc. enjoyed a fine rise in July and part of August, briefly touching $70, but has weakened considerably since then. At this point, in early September, you can see that we have a chart pattern which is very close to a finished head-and-shoulders formation. This bearish formation appears when a stock runs into decisive resistance ($70), and during its price retreat, former price resistance ($61.50) does not become price support. Instead it falls through that key level and enjoys a bounce at a lower support level ($55). The H&S pattern signals a stock which is viewed by earlier investors as being unlikely to resume an up trend. A period of reduced volume at the last support zone acts as confirmation that new investors are not taking up the slack. This particular H&S pattern is not perfect, but it seems close enough to take note of. The pattern implies a move to tertiary support (about $53) with a possibility of momentum carrying it well below, to a target as low as $48.

An alternative categorization of the pattern would be as a descending triangle. The prognosis remains virtually the same, but in the case of a descending triangle the time scale could be much longer.  Given the uncertainty, a strategy which works for both possibilities is called for.  Recall the last time I wrote an article on a descending triangle - the stock was FSLR, at $180, and my forecast was a fall to as low as $140.  The stock soon began a slide that is now taking it well under $120.

I chose to play the stock using a Bearish Call Spread. This strategy allows you to make a quick profit if the stock plummets (typical of a H&S pattern) or a slow profit if the stock dawdles just above $55 (which you might expect if we are seeing an extended descending triangle.) The spread consists of

Short QGMIL Sep 60 GMCR call
Long QGMIM Sep 65 GMCR call

The spread right now pays about $135 per contract pair at expiration, assuming GMCR remains less than $60. Each pair of the spread requires $500 maintenance margin, with 12 trading days to expiration.

Of course, you could simply watch the chart and take on a short position or buy puts and wait for a big move down, but don’t forget, it is September now, and a churning market is fairly common this time of year. The spread means that time is on your side, so it might be the better choice.

Good luck!

by Skymist