Name That Trade – $YUM – Structures For Existing Longs Into Tonight’s Print

by CC July 10, 2013 1:44 pm • Commentary

Dan previewed YUM’s Q2 earnings yesterday (below) and although we’re not going to take a stab on the name before earnings we wanted to show some structures that make sense for those wishing to protect an existing long or add upside leverage to a long in case of a breakout on earnings.

For Existing Longs (downside protection):

Theoretical Trade – YUM ($72.25) Sell the Oct 77.50 call to buy the Oct 70/65 put spread for even
  • Sell 1 Oct 77.5 call at 1.52
  • Buy 1 Oct 70 put at 2.95
  • Sell 1 Oct 65 put at 1.43

Rationale – This structure gives a good amount of downside protection if the stock was to break its 50 day moving average of 69.80. Support below that could come at its 200 day at 68.30, but below that is a pretty big air pocket down to 64. In case of a big move down on earnings, this is great protection against your long.

The flipside is that you are essentially giving away your stock at 77.50 but that’s a pretty decent breakout above its recent highs of 74 so not a terrible trade-off. Additionally, if the stock doesn’t make a big move either way, this position could be taken off for not much damage or a small profit vs. your small profit or loss in the stock and will have allowed you to carry your long through a risky event.


For Existing Longs (adding upside leverage, slight short delta hedge):

Theoretical Trade –  YUM (72) buy the Oct 77.5/80 1×2 for 30c credit
  • Buy 1 Oct 77.5 call for 1.50
  • Sell 2 Oct 80 calls at 90c (1.80 total)

Rationale –  This structure is interesting against an existing long because it essentially supercharges your long on a breakout towards 80 in the stock, but also takes advantage of elevated IV in OCT that will benefit from a fall in vol after earnings. If the stock was to stay relatively unchanged after earnings this trade should be a slight winner, if stock is down slightly it’s also a slight winner as it’s short about 12 deltas. If the stock is up slightly it is probably a push (vol coming in cancels out short deltas) and if it’s up big you are making money in your stock, have a slight loss on your options, but as we get closer and closer to Oct expiration, those greeks start to work in your favor and if the stock were to close at or above 80 on Oct expiration you would have essentially supercharged your long and sold your stock at 82.80.




Original YUM Preview

Event: YUM reports Q2 earnings tomorrow after the close, the options market is implying about a 4.5% move which is almost exactly in line with the 4 qtr avg move and rich to the 8 qtr avg of about 3.25%.

Sentiment:  Wall Street has been fairly mixed on the stock for sometime given the fears of growth decelerating in China, analysts are almost evenly split on the stock with 12 Buys, 14 Holds and only 1 Sell with an avg 12 month price target of ~$73, less than half a percent from where the stock is currently trading.   Short interest has dropped about 1% to 1.6% from the recent 52 week highs in the spring in an around the height of Bird Flu fears in China. 

Options Open Interest:  Total open interest is slightly skewed towards puts with 88k to 79k in the calls.  The largest single open lines are 10k of the July 70 calls, 8k of the July 62.5 puts, 7k of the Jan14 62.5 puts, 6700 of the July 67.5 puts, and 6k of the July and Jan14 60 puts.

Volatility Snapshot:  30 day at the money implied volatility (blue line), while elevated into tomorrow’s earnings report is not as high as levels seen prior to the last couple reports while the gap btwn realized volatility (white line) is far narrower than in quarters past, suggesting investors perceived comfort level heading into the print.  At the money IV is likely to fall back to the low 20s barring an outsized move one way or the other.

[caption id="attachment_27871" align="aligncenter" width="589"]YUM 30 day at the money IV vs 30 day realized vol from Bloomberg YUM 30 day at the money IV vs 30 day realized vol from Bloomberg[/caption]

Price Action / Technicals: Despite having its share of nasty headlines out of China (slowing growth and bird flu fears) YUM has traded pretty well up ~10% ytd and now only 2.25% off of the 52 week highs on made last November and just 3% from the all time highs made in Q2 2012.

Looking at the 2 year chart, $75 is clearly the line in the sand, a gap above that level could cause a fairly powerful break-out.

[caption id="attachment_27879" align="aligncenter" width="589"]YUM 2 yr chart from Bloomberg YUM 2 yr chart from Bloomberg[/caption]

On a shorter term basis the stock has fairly reasonable resistance at $74 and $equally strong support just above $68 which happens to be the 200 day moving average.

[caption id="attachment_27883" align="aligncenter" width="589"]YUM 1 yr chart from Bloomberg YUM 1 yr chart from Bloomberg[/caption]

Fundamentals:  This morning  Oppenheimer raised their price target in the stock from $72 to $80 suggesting that despite worries of weak Chinese growth, YUM’s recent problems in the country where they get almost 45% of their sales is set to re-accelerate in 2014 and that earnings will highlight better than expected operating leverage as the company better contains costs.

Back on June 11th, YUM released their May same store sales, that were down 19% in China, which despite sounding dismal was up sequentially and slightly better than the -20% expectation.  This disclosure should make Q2 a tad less of a mystery and the stock will likely trade on future outlook.

MY VIEW:  I don’t trust China and frankly I am not sure I trust the guidance that YUM’s management is about to give.  Despite facing fairly low expectations, I have to assume visibility is fairly poor considering that few have a good sense just how hard the economic landing will be in China.  I am not of the mindset to play for break-outs to all time highs in this market, and if I were to play from the short side, targeting a move to support at the bottom end of the trend channel would be the way to play for worse than expected Q3 and 2h guidance.

We’ll look at various strategies and if something looks good will publish later on the site.