New Trade – $MA: Not Quite Priceless

by CC September 19, 2014 10:51 am • Commentary

In a market that is currently known for its low volatility and complacency as it relates to risk taking, the chart in Mastercard (MA) is illustrative of a stock taking a breather after a huge run. In 2013 the stock showed some signs of life running up to 84 after starting the year at 50. But when the calendar turned, the selling started and it quickly sold off to about 70 in early February. Since that time, the stock has essentially been in a range between 70 and 80 with most of the time spent going sideways at $75. That sideways motion is particularly noticeable during the past few months as the stock has essentially held a 4 dollar range since early summer:

MA daily chart, courtesy of Bloomberg
MA daily chart, courtesy of Bloomberg

Part of the reason why MA stock has traded in such a tight range is that the business has remained very steady (15-20% EPS growth over the past 3 years), but valuation had gotten very stretched at the end of 2013.  Here is the trailing 12 month P/E over the past 5 years:

MA 12 month trailing P/E, courtesy of Bloomberg
MA 12 month trailing P/E, courtesy of Bloomberg

The consolidation in MA over the past 9 months is a reflection of market participants re-rating MA’s valuation multiple gradually lower as earnings catches up to the stock’s rapid appreciation in 2012 and 2013.

Implied volatility in the name is low historically but the realized vol in the stock is much lower.  This is a situation where the implied vol in the options, even when at historic lows, is still overpricing risk, as long as the recent volatility regime holds:

30 day implied vol in blue vs. 30 day realized vol in white, courtesy of Bloomberg
30 day implied vol in blue vs. 30 day realized vol in white, courtesy of Bloomberg

Earnings is in late October for Mastercard.  With no events on the calendar between now and October expiration, this sets up as a good candidate for a range trade, taking advantage of the low likelihood of the stock being able to break out from the range it’s spent so many months trading in. So here’s the trade:

TRADE – Buy the MA ($77.90) Oct18th 80/75/70 put fly for 1.85

– Buy 1 Oct18th 80 put for 2.82

– Sell 2 Oct18th 75 puts at 0.55

– Buy 1 Oct18th 70 put for 0.13

Breakevens on Oct18th Expiration:

Losses of up to 1.85 above 78.15 and below 71.85. Total losses of 1.85 above 80 or below 70. Max gain of 3.15 at $75

Rationale – This centers a range trade at $75 which has been the center of the recent range in the stock for the past several months. The risk reward of this structure versus the realized volatility in the stock makes it a good structure. The main risk is the stock going to $80 immediately or and spending the next few weeks consolidating near the upper part of the range (or simply breaking higher).  This, and the fact we’re centering the trade at 75 with the stock at 77.50 means that we’ll have to keep a much tighter leash on the structure to the upside than we will to the downside.

We actually had a similar trade a few months ago that we took off for a nice winner.  The trade management will be similar – we will try to hold the position between $71 and $79 and let time decay bleed on the short 75 strike options, though we will look to exit if the stock spends much time near either longs strike.