Further Downside Brewing for Starbucks (SBUX)?

Growing number of put options in open interest

The price for shares of Starbucks Corporation (SBUX) recently continued its wider losing streak after the company reported earnings for the fiscal first quarter. Starbucks beat analysts' expectations for revenue but missed on earnings per share (EPS). Analysts expected the company to announce $0.80 in EPS and $7.5 billion in revenue for the quarter—Starbucks reported $0.72 in EPS along with $8.05 billion in revenue.

The company said that rising costs and supply chain constraints are weighing on profits. A resurgence of COVID-19 meant paying more employee sick leave. The company cut its earnings outlook for fiscal 2022, causing investors to sell off Starbucks shares by 1% the day after the company reported earnings. The share price has continued to decline and is trading in a below average range based on historical volatility.

Option traders appear to be placing their bets on further downside for Starbucks shares in the near term. That's because, while recent trading volumes and the open interest for Starbucks are nearly split between call options and puts, implied volatility and close-to-the-money options suggest that traders are buying downside puts while selling upside calls.

Key Takeaways

  • Traders and investors bid down the share prices of Starbucks following the earnings announcement as the stock fell 1%.
  • The share price of Starbucks remains in a downward trend that had slightly paused before earnings.
  • Starbucks shares recently closed below a thin zone of selling based on volume.
  • Implied volatility and open interest appear to suggest that option traders expect further downside for Starbucks.
  • The volatility-based support and resistance levels allow for a stronger move to the upside.

Price Action

A comparison between technical analysis of share price movement and recent option trading activity can grant chart watchers valuable insight into the overall sentiment toward Starbucks stock ahead of the earnings announcement. The chart below illustrates the recent price action for the Starbucks share price as of Thursday, Feb. 3.

Recent price action for SBUX

The chart illustrates the Starbucks share price behavior since it reported earnings for the prior quarter. After third quarter earnings, Starbucks shares floated above and below the 20-day moving average, remaining in an average range. At the beginning of 2022, Starbucks shares began a prolonged downward trend, highlighted by the red arrow. In the week before earnings and a few days after, Starbucks stock traded relatively sideways, highlighted in blue. This could mean that traders remain unsure of the future trend for the Starbucks share price.

The purple bands on this chart are an extreme historical volatility range formed by 4 standard deviations of 20-day Keltner Channel indicators, which depict price levels that represent a multiple of the average true range (ATR) for Starbucks stock. ATR is a standard tool for illustrating historical volatility over time. These bands could be considered to represent the extreme ranges of option pricing.

Relation to Sector

Starbucks is a part of the consumer discretionary sector. This sector comprises businesses that sell nonessential products and services that consumers may avoid without any major consequences to their well-being. Consumer confidence plays a central role in this sector, and its performance can be used as a mild gauge of sentiment toward inflation. During times of high inflation, this sector tends to fall, as consumers will "tighten their belts" on wants compared to needs.

The chart below compares Starbucks with State Street's Consumer Discretionary Sector ETF (XLY), top restaurant industry competitor McDonald's Corporation (MCD), and the Barclays iPath Coffee ETN (JO).

Comparison of SBUX, XLY, MCD, and JO

This chart helps to highlight the precipitous downward trend that both Starbucks and XLY have endured since the beginning of 2022. Starbucks has lagged its sector, while top restaurant industry competitor McDonald's has outperformed XLY and Starbucks.

JO tracks a single coffee futures contract at a time, purchased two or three months out and held until the month of maturity. JO serves as a viable option for getting exposure to coffee prices via futures. Starbucks cited rising prices as a main reason for poorer than expected results on the bottom line. With JO on the rise, it could mean that Starbucks will continue to endure higher-than-expected costs. JO and Starbucks do not have an explicit inverse relationship, but it is worthwhile for investors to take heed of price behavior of the main product that Starbucks provides.

Volume Profile and Option Outlook

A comparison between price action and option trading can provide insight into the sentiment of traders and investors toward a company's performance in the near future. However, further context of price action in terms of volume could illustrate areas of support or resistance, which could provide context to option open interest. The chart below illustrates the recent price action of Starbucks, in addition to a price-based volume pattern on the left-hand side.

Recent price action of SBUX, in addition to a price-based volume pattern

This price-based volume pattern depicts the prices where investors have bought and sold the shares previously. A noticeable amount of buying in the past often implies that investors will feel the desire to defend their positions at those same prices by buying more shares or at least not selling any further. When volumes at a given price are low or nonexistent, it implies that few, if any, investors have the need to defend their positions at these levels.

This chart highlights how the pre-earnings Starbucks share price movement fell below a thin zone of selling based on volume This area is highlighted by the red rectangle. If the Starbucks share price were to move to the upside, this thin zone could prove to be a significant area of upside resistance.

Option traders appear to be positioning themselves for the overall downward share price trend to continue. Recent trading volumes are nearly even in terms of calls versus puts: 35,000 to 29,000. Despite the slight bullish edge in trading volumes, open interest is slightly bearish, as it features 255,000 calls compared to 264,000 puts. Further analysis is required.

For Feb. 18, the next monthly option expiration day, the single option with the highest open interest is the $95 put, with 15,000. For strikes at the money and one step in either direction on either side of the option chain, the open interest features 16,000 puts compared to 2,000 calls. This 8-to-1 ratio reflects an incredibly bearish sentiment toward Starbucks in the near term.

Implied volatility also paints a further picture on this open interest. Implied volatility for upside calls is falling while the open interest is rising, suggesting that option traders are taking short positions in these options. Conversely, implied volatility for downside puts is rising as the open interest is rising, indicating that traders are buying these options.

Wrapping Up

Option traders are buying puts and selling calls in anticipation of future downward share price movement for Starbucks stock. The consumer discretionary sector has greatly underperformed the market of late as investors appear to be rotating into safer sectors due to inflation.

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