New Trade Coca-Cola: If Market Rally Finally Gets KO’d

by Dan April 3, 2012 11:12 am • Commentary

KO ($74.05) reports it’s fiscal Q2 earnings before the opening on Apr 17th.  The options market isn’t implying much of a move (~1.25%), because generally the stock doesn’t move that much (~1.25% over the last 8 qtrs).

-Even-though KO severely lags the broad market this year (SPX up 12.6% vs KO up 5.4% ytd), the stock is trading at 52 week highs and levels not see since 1998.  The stock’s defensive nature may make it a relative under-performer, in a raging bull market, but it’s 2.77% yield is likely to keep the stock grounded in a prolonged bear market.

-That said, the stock is not by any means cheap trading at about 18x 2012 earnings estimates that are only expected to grow about 6%, while sales are only expected to increase a paltry 3%.

-Technically the stock appears to be a bit overbought at current levels and in line with market call hat we are likely to see a pullback prior to the meat of Q1 earnings and prior to Apr expiration I want to play names like KO where I believe the options market is not adequately pricing in the potential for movement.  Stock has recently broken out of a 2 year trend channel and barring any company specific disasters, the stock will likely trade with the market, and establishing a new range above the $70 level.

[caption id="attachment_10264" align="aligncenter" width="300" caption="2 YR KO Chart from Bloomberg"][/caption]


Volalitilty in a stock like Coca-Cola is on the low side and tends to stay that way. Skew is generally between ATM options and OTM options both to the upside and to the downside due to the dollar cheap aspect of the OTM options. (the OTM get bid up vol wise because they tend to trade under a dollar to begin with)

Here’s a look at the skew both between months and the upside and downside options within each month:

[caption id="attachment_10259" align="aligncenter" width="527" caption="KO Monthly vol skew from LiveVol Pro"][/caption]

Historically you don’t see massive moves in volatility even leading up to earnings dates. What you’ll notice is that vol spikes generally come during times of overall market uncertainty. This makes sense given KO’s global reach:

[caption id="attachment_10261" align="aligncenter" width="597" caption="KO IV vs HV 1 year from LiveVol Pro"][/caption]

Here’s a look at the recent quarterly earnings moves in the stock:

[caption id="attachment_10260" align="aligncenter" width="596" caption="KO earnings charts from LiveVol Pro"][/caption]


MY VIEW & NEW TRADE:  KO is overbought and expensive, and I am looking for cheap vol with catalyst to play what I think is a very likely broad market sell off in the next few weeks.

TRADE: KO (74.05) Bought the May 72.50 / 70 Put Spread for .42

-Bought 1 May 72.50 Put for .66

-Sold 1 May 70 Put at .24

Break-Even on May Expiration:

Profits btwn 72.08 and 70 make up to 2.08, with max gain of 2.08 below 70.00

Losses of up to .43 btwn 72.08 and 72.50, with max loss of .42 above 72.50

* I am selling the May 70 call, even-though just a 12^ as I think 70 is very likely to be the floor the stock in the near term, down about 5% and the level at which is just broke out.