Traders Could Make 150% Profits as This Overvalued Giant Stumbles

Traders Could Make 150% Profits as This Overvalued Giant Stumbles By Michael J. Carr & Amber Hestla December 15, 2012   Print | PDF | Over many holiday shopping seasons, retailers have developed strategies to increase their profits. One of those strategies is making it easy for consumers to find products that are big sellers. This holiday season, during shopping trips to almost any large retailer that sells household items, SodaStream home soda makers and supplies seem to be impossible to miss. These products, made by SodaStream International (NASDAQ: SODA), are prominently on display in many stores, which prompted us to look at whether there is a way to profit from a do-it-yourself soda trend. Also In Today's Issue Discover a Hidden World of Wealth I've discovered a way for investors like you to legally and safely tap into a windfall of profits. 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When we noticed this trend and looked at the industry, we were struck by how overvalued PEP is. Whether SODA succeeds or not, PEP looks ready to enter a bear market. The stock is selling with a P/E ratio of about 19, and the P/E ratio is near its upper Bollinger Band, indicating that the stock might be overvalued. Analysts expect future earnings growth for PEP to average about 4.25% a year. Fair value for a stock is sometimes defined as the price where the P/E ratio is equal to the earnings growth rate, an indicator known as the PEG ratio (calculated as the P/E ratio divided by the earnings growth rate). The PEG ratio for PEP is about 4, and if the PEG ratio fell to 1, then the stock would trade at about $16. PEP is unlikely to fall that low, but it does appear likely that it will fall. PEP seems to have reached resistance on the weekly chart, and the RS is low and falling. This is a stock that looks like a short trading candidate. To be a good short trade, the stock should be fundamentally overvalued and technically bearish. Ideally, short trades will be in large-cap stocks that have high trading volume because liquidity reduces the costs of the trade and also reduces the chance of a short squeeze. In a short squeeze, traders who hold long positions in stocks can demand the immediate return of borrowed shares and force shorts to cover their positions, which drives prices up, especially in thinly traded stocks. Risks like that make many traders reluctant to enter short trades. But refusing to make short trades can hurt performance since stocks go down as well as up. Long-only traders miss out on the downside. Instead of selling a stock short, traders can benefit from price declines by buying put options, which limit the risk to the amount paid for the put. Costs are limited to standard commissions and fees, unlike short trades, which can include costs for dividend payments and costs associated with the borrowed shares. The major advantage of a short trade compared to a put option may be the fact that time is less of a factor for the short trade. Put options expire while the short position can be carried as long as the trader is willing to hold it. For those willing to short PEP, the trade could be entered at the market price with a stop-loss at $73.75, just above the 52-week high. In dollar terms, the risk is about $3.65. Puts expiring in April with an exercise price of $72.50 are trading at about $3.80, and that would be the total amount of dollar risk on the trade. PEP has support near $62, which offers a price target for this trade. Buying puts offers less risk than short trades but requires a trade to work within a prescribed time frame. Shorting a stock allows for unlimited time for the trade to work but comes with potentially higher trading costs and greater risk. Both trades could benefit from a downtrend and traders should consider using at least one of the strategies in their trading account. Recommended Trade Setup: Stock Trade Options Trade Sell PEP short at the market price Buy PEP April 72.50 Puts at $4 or less Set stop-loss at $73.75 Do not use a stop-loss Set price target at $62 Set price target at $10 Potential Profit: 12% Potential Profit: 150% Editor's note: Thank you for reading today's issue. As always, you can send feedback to Editorial@TradingAuthority.com. Dr. Melvin Pasternak's Trades & Updates Company (symbol) Trade Type Buy/Sell Date Buy/Sell Price Stop-Loss Current Price Total Return SPDR High Yield Bond ETF (NYSE: JNK) Long 01/30/12 $39.94 $34.98 $40.76 +2.1% The Hershey Company (NYSE: HSY) Long 07/02/12 $71.04 $64.89 $74.02 +4.2% Michael Kors (NYSE: KORS) Long 10/08/12 $53.33 $44.30 $49.88 -6.5% Endeavour Silver (NYSE: EXK) Long 11/05/12 $8.82 $7.16 $8.20 -7.0% Costco (NASDAQ: COST) Long 12/03/12 $104.82 $93.56 $96.92 -7.5% View all closed trades here. Stock prices in this issue are as of the close of trading on December 14. SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK) gained slightly over the week. Shares are currently trading between the middle and upper Bollinger Bands. Daily RSI remains above the overbought 70 level; however, strong securities can become and stay overbought for long periods. Daily MACD is still on a "buy" signal. I'm currently up about 2% on the trade. My stop-loss of $34.98 and target of $48.01 remain. The Hershey Company (NYSE: HSY) made steady gains throughout the week. Shares are currently testing resistance, marked by the upper Bollinger Band. Daily RSI appears on the verge of hitting overbought territory, at the 70 level. Daily MACD and stochastic are both giving "buy" signals. I'm ahead about 4% on the trade. My stop-loss of $64.89 and target of $79.50 hold. Michael Kors (NYSE: KORS) moved lower throughout the week. The stock is currently trading between support, marked by the lower Bollinger Band, and resistance at the 20-day moving average, marked by the middle Bollinger Band. Daily RSI is below the key 50 juncture. Daily stochastics appears to have bottomed and should be due for a reversal. My stop-loss of $44.30 and target of $64.98 remain. Endeavour Silver (NYSE: EXK) rose most of the week, before retreating Thursday. The stock is currently trading between support, marked by the lower Bollinger Band, and resistance at the middle Bollinger Band. Daily RSI is below the key 50 juncture. Daily MACD appears to be on a tentative "buy" signal. My stop-loss of $7.16 and $12.50 price target (or until the options expire in May) hold. I am also credited with an option premium for writing calls. Costco (NASDAQ: COST) slipped throughout the week. Shares are currently trading between support, marked by the lower Bollinger Band, and resistance at the middle Bollinger Band. Daily RSI is near the overbought 70 level, but not there yet. Daily MACD is still on a "buy" signal. My stop-loss of $93.56 and target of $114.69 hold. -- Dr. Melvin Pasternak  Co-Editor, Trade of the Week 2 Stocks Set to Take a Dive When This Wall Street Mania Ends 3 Trades That Could Deliver Up to 20% in the Next 10 Weeks This Could be the World's Next Great Investment... and it's Signaling a 'Buy'         Disclosure: None. 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