Is Best Buy a Bad Buy?

07/15/2009 11:00 am EST

Focus: OPTIONS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer’s Investment Research says there’s too much optimism about the consumer electronic giant’s stock, making it vulnerable to a sell off.

Best Buy (NYSE: BBY) has begun selling green vehicles, according to The Wall Street Journal (“Best Buy to Sell Green Vehicles," July 6th).

“America's largest consumer-electronics retailer has quietly begun offering electric-powered scooters, bicycles and Segway transporters in 19 locations in California, Oregon and Washington," the Journal reports.

The move toward green vehicles is designed to help the company increase market share. Best Buy already boosted its share of the US market by two percentage points in the first quarter, picking up business from the failed Circuit City Stores. Still, the firm's earnings fell 15% in the first quarter, and sales at US stores opened at least 14 months dropped 4.9%.

While the green scene looks promising, the company has a history of failed ventures. Most notably, the company purchased Musicland Stores in 2001, just as Internet piracy hit its stride, while "the jury is still out" on its purchase of Napster. for $121 million last year.

One thing is certain when it comes to Best Buy: The company needs a boost to sustain its 2009 growth. The shares are up more than 20% this year, but that momentum is fading quickly. After peaking near $42 per share in late April, BBY has given back [almost 20% of its value.] Currently, BBY is suffering under the weight of its ten- and 20-day moving averages, and has pulled its ten- 20-week trend lines into a bearish cross. This latter technical formation has bearish implications for the equity over the intermediate term.

On the sentiment front, investors remain solidly bearish [on] BBY. Short interest, for instance, accounts for a sizable 7.6% of the stock's total float, while nine of the 17 analysts following the equity rate it Hold or worse. However, Thomson Reuters reports that the consensus 12-month price target for BBY rests at $41.35 per share, hinting that analysts are expecting the shares to rally more than 20% within the next year. [So,] there is still some lingering optimism that could be unwound to the detriment of BBY shares. (The stock closed above $34 Tuesday—Editor.)

Option traders, on the other hand, are overwhelmingly bullish toward BBY, presenting a considerable risk to the down side for the security. Specifically, the stock's Schaeffer's put/call open interest ratio (SOIR) of 0.74 ranks below 99% of all those taken during the past year, as calls easily outnumber puts among options with less than three months until expiration.

If BBY continues its poor price action, it may take more than a move toward green vehicles to bolster investor confidence in the company. Traders should keep an eye on the options pits for a shift toward put options, as this could be a signal of capitulation, and a precursor to an extended decline for the equity.

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