Thursday, June 12, 2014

* Keurig Green Mountain (GMCR) - Stock Pops, Volatility Pops on 'Subway' Deal. But Have We Missed the Risk Here?

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GMCR is trading $122.06, up 5.2% with IV30™ up 16.3%. The Symbol Summary is included below.

Provided by Livevol

The company's financials are improving rapidly, a breakaway smash product hit has crept into the very name of the firm, the stock is up 8000%+ in 10-years and 400% in about 1.5 years.  The risk as reflected by the option market is dripping, there's more certainty surrounding earnings (per the option market), but... have we forgotten how volatile this company can be?

This is a stock, volatility and valuation story that has some news (albeit old (?)) as a catalyst for the stock move today. Here's some news:

Yesterday afternoon, Keurig Green Mountain announced a partnership to bring thousands of its Keurig K150 commercial brewers to Subway restaurants across North America.

For the record, this partnership isn't entirely new. A little over a year ago, the K150 actually became Keurig's first small- to medium-capacity brewing system to be certified by the National Sanitation Foundation for use in foodservice outlets. Shortly afterward, Subway began offering the K150 as an option to its franchisees.

Apparently they've loved it ever since; as of right now, Subway says more than half of its locations in the U.S. and Canada have already adopted the system.

Source: The Motley Fool via Yahoo! Finance Why Keurig Green Mountain Inc and Subway Are a Perfect Match, written by Steve Symington.

That news has pushed GMCR on the brink of an all-time time, and in the meantime there have been some very interesting phenomena developing on the risk front (implied volatility).

Let's start with the Charts Tab (ten-years) below.

Provided by Charles Schwab optionsXpress

Over the ten-year period the stock is up 8,322%, so just a little better than my personal portfolio (that was a joke...).  But, inside that ten-year period we can see an awesome run-up, a frightening collapse in the midst of a bull market (note the dates on the bottom of the chart), and then an incredible pop back from below $25 to now over $122 in about 1.5 years.

Before we get to the options and volatility story, let's just take a quick snapshot of some key elements off of the income statement (annual, four-years), below.

Provided by

However you slice it, the company is growing like gang-busters.  A nice feature offers by default is the little bar chart next to each line-item (highlighted in green).  Basically, with even digesting an actual number, we can see the charts are going in the same direction; up. It's this undeniable trend that is pushing the stock up.

One other thing to note, the name of the firm changed to include the name "Keurig." That name change was announced by the WSJ (and a bunch of others) on January 14th of this year, "a recognition of the increasing importance of the single-cup brewing system that made it famous." (Source: Green Mountain Coffee to Change Name to Include Keurig Brand).

OK, so that's what happens to the stock price when financials improve and a new product is a breakaway smash hit. What about the risk?...

Let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days). So this is a two-year chart that graphs the forward looking risk in GMCR.  Two phenomena to note:

1. The risk into earnings has been dropping substantially (the blue "E" icons represent earnings dates).  That's a reflection of greater transparency into the future of the business, and improving financials.

2. The overall level of the risk is pretty low as of right now (i.e. today).  In fact, it's in the 22nd percentile when compared to the last 52 weeks.

So we see a company providing superior returns and the option market is pricing in less future risk.  I ask the same question posed at the top: "have we forgotten how volatile this company can be?"

Of course, there's more...

The Skew Tab snap (below) illustrates the vols by strike by month.

Provided by Livevol

I have included both the Jun (yellow) and Jul (pink) option expries.  We can see the implied volatility (risk) by strike price for each month.  I note:

1. Jun is above Jul for all strikes (the yellow curve is above the pink curve).
2. Both expiries show a parabolic shape, which means the option market reflects two-tailed risk.  The downside risk is "normal" skew.  The upside potential is "abnormal" skew.

To read more about skew, what is and why it exists you can click the title below (trust me, it's worth the 3 minutes): Understanding Option Skew -- What it is and Why it Exists.

Finally, the Options Tab is included below.

Provided by Livevol

Using the at-the-money (ATM) straddle we can see that the option market reflects a price range of [$114.50, $129.50] by the end of trading on Jun 20th.

  • If you believe the stock will be outside that range on expiry or any date before then, then you think the volatility is too low.
  • If you believe that range is too wide, and that the stock will definitively be in that range on expiration, then you think volatility is too high.
  • If you're not sure, and can make an argument for either case, then you think volatility is priced just about right.

This is trade analysis, not a recommendation.

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