Name That Trade – $PEP: Pepsi Growth Still Challenged

by Dan January 20, 2015 3:17 pm • Commentary

Earlier today there was some call activity in shares of Pepsi (PEP) that got me thinking about a poorly time bearish trade that I initiated in late September in the stock (New Trade – $PEP: Pepsi Challenged). It expired worthless on Friday’s close.  While my earlier trade was a bust, and to be frank we usually have very few where we lose all of the premium at risk, I stand behind the thesis and it is one I plan to be revisiting very soon.

Earlier when the stock was $97 a trader sold 6,000 Feb 101 calls at .54 to open. This was likely a long holder overwriting 600,000 shares. If the stock is below 101 on Feb expiration the investor will receive $324,000.  Seems like a fairly paltry potential added yield to stock that already yields 2.7%. The call sale is less than the quarterly dividend of 65 cents.

But here is the thing. If I owned PEP, I would be looking to do as much nipping and tucking as possible.  This is a stock that makes little sense to me on a valuation basis. It’s trading at 20x expected eps growth of 5% on expected sales growth of only 1% (after no growth in 2014).  This is a clear example of the company’s nearly $5 billion in share buybacks manufacturing earnings growth.

But why in the world would investors pay 21x for that sort of growth??  P/E is reaching 7 year highs, per Bloomberg:


One reason for the call sale could be the rise in implied volatility of late, with 30 day at the money IV near 52 week highs:

[caption id="attachment_50078" align="aligncenter" width="600"]PEP 1yr chart of 30 day at the money IV from Bloomberg PEP 1yr chart of 30 day at the money IV from Bloomberg[/caption]

Technically the stock has made a very nice base over the last few months, and frankly looks poised to take another shot at the highs from early December:

[caption id="attachment_50079" align="aligncenter" width="600"]PEP 1yr chart from Bloomberg PEP 1yr chart from Bloomberg[/caption]

On the downside, targeting $90, the October low, from an entry closer to $100 seems like the trade set up of choice for this guy who got burned in both timing and and price entry on my last go around.

But for those who are long, and riding the stock’s defensive bid, call sales at or near the prior highs make a lot of sense to me.