What’s more American than stopping by your local Starbucks in the middle of a summer heat wave to order a $5.40 caramel macchiato? With this short trading week leading into the Fourth of July holiday, let’s take a look at how we can make a high-probability trade to go long the coffee giant or short the java bean.

SBUX has an implied volatility rank of 72 right now. Implied volatility rank is a measure of how high option prices are relative to the prices over the last year. This is elevated because the second-quarter earnings announcement is slated for July 26. At an implied volatility rank of 72, the options are rich with premium, not the type of setup where you would want to buy an option, but you can take advantage of these high prices by selling options.

Going out 45 days is the optimal time when premium decays quickly without having excessive risk of being in the money. Today we will look at a trade setup expiring on Aug. 17.

I typically look at the 20-30 delta when I’m placing a trade. This gives me a 70 to 80 percent probability that the options I sell will stay out of the money and that the trade will be profitable by expiration. The elevated option prices take into account not only the time until expiration, but also the expected earnings move. However, be aware that once earnings are two to three days out, the pricing may spike again, showing short-term losses until the option prices settle back down.

I’m fully caffeinated so I’m ready to go long with selling a 47 Put and buying a 45 Put. This bullish Put spread is worth $45 right now and has a max risk of only $155, or the equivalent of just three shares of stock with the current price at $49.06. This has a 71 percent probability of profit, as the 47 Put shows a delta of 29 as of July 3. Better still, the breakeven on the trade is down at $46.55, or 5.1 percent below the current stock price.

Let’s say you’ve had enough of the joe and you’re ready for some herbal tea instead. You steep your opinion by shorting SBUX with a short Call spread. By selling the 50 Call and buying the 52.5 Call, you’re taking in a credit of $76 and have only $174 in risk with a trade that has a 56 percent probability of profit. There are fewer Call strikes to choose from, which tells me that there’s less demand for Calls by buyers and sellers. So we had to get a little closer to the money in order to find premium to sell. Still, with the breakeven at $50.76, that’s 3.4 percent away from today’s stock price.

In order to make the kind of dollar return like on the Put spread of $45 by buying three shares of SBUX, the stock would need to go up to $64.06 — or 30 percent — in the next 45 days. Odds are that’s not going to happen. This is one of the many ways that by using options, we can have much higher gains than by buying stocks outright and have a 71 percent probability of profit, too!

Christopher M. Uhl, CMA, MOSM
Email: chris@10minutestocktrader.com
Twitter: @10minutetrading
Instagram: @10minutetrading