Name That Trade $DPZ: Playing Dominoes

by Dan September 27, 2013 3:20 pm • Commentary

Tonight on Options Action on CNBC at 5:30pm I was asked to take a look at Dominoes Pizza (DPZ) as my friend, the illustrious chartist  from Oppenheimer, Carter Worth has a a bearish view on the stock.

As I do not know what he is going to say yet, I will just give you my quick take and how I would play if I were forced to create a bearish structure with options.  First things first, the one year chart looks like many other small to mid cap growth stocks that have massively outperformed the SPX year to date.

DPZ 1yr chart from Bloomberg
DPZ 1yr chart from Bloomberg

The stock has held the uptrend that has been in place since the Oct 2012 lows, and consistently makes higher highs after healthy consolidations.  If I were to target a pullback range, it would likely be to the $60 support level that served as resistance in the spring.

Looking at the stock, the next real catalyst will be their Q3 earnings scheduled for Oct 15th, where the options market is implying about a 5.5% move vs the 4 qtr avg of about 5%. I think it is important to note that in July when DPZ reported their Q2, despite slightly better than expected results the stock got drilled, down 6.5% for no apparent reason.  Since then the stock has come back from the lows it made soon after below $60 and has  rallied 20% sitting within a percent of the all time highs and up 55% on the year!

I would add though, the stock is priced for perfection (much like NKE prior to today’s 5% earnings gap to all time highs on their earnings beat), so bears please take note.  But lets be honest this is a low cost providers of PIZZA, that trades at 24x next years earnings that are expected to grow only 14% (decelerating from expected growth this year of 21%) on sales growth of only 4%.  It appeared that one of the reasons for this years rally was investor excitement about cash return, but the company is already fairly levered with $1.55b in debt, no real cash to speak of and a market cap of $3.7b while already paying a dividend that yields 1.2%

Make no mistake about it, the stock has been a monster in 2013, and it has the sort of momentum where if you are long my suggestion is to just hold on and keep raising your stop, but for those contrarians out there, Oct put spreads into earnings could make sense (this is not a trade that we are putting on, merely for educational purposes, but it is a name that we would look at closer if the strikes lined up a little better and there was a meaningful change in implied vol heading into or out of the earnings event) :

Hypothetical Trade: DPZ ($67.50) Buy Oct 65/60 Put Spread for .90

-Buy 1 Oct 65 Put for 1.20

-Sell 1 Oct 60 Put at .30

Break-Even on Oct Expiration:

Profits: btwn 64.10 and 60 make up to 4.10, max gain of 4.10 below 60

Losses: up to .90 btwn 64.10 and 65, with max loss of .90 above 65

Trade Rationale:  RISKING less than 1.5% of the underlying. that the stock is down 5% to just break-even, not a fantastic risk reward, but with $5 wide strikes few ways with defined risk and long premium to make directional bets, would be inclined to sell a call spread but risk reward there is even worse.