Considering Our Options – $YUM Feb Put Spread

by CC February 4, 2015 12:37 pm • Commentary

YUM reports its q4 results today after the close. We legged into a put spread last week for the event and just want to check in beforehand. To recap, we intially bought the Feb 72.5 puts when the stock was 72.75. We then got a chance to spread those puts with a sale of the Feb 68 puts after the stock fell to 71.10. So here’s our current position:

New Position: YUM ($71.10) Long Feb 72.50 / 68 put spread for 1.00

With the stock now higher at 73.85 this structure is worth about what we own it for. So let’s look at the set-up into earnings and whether we’re comfortable holding into this potentially binary event. The structure is about 23 deltas and it is slightly out of the money. Its breakeven is 71.50 which is just inside the event move the options are implying. (The Feb6th weekly 74 straddle is about 3.75, implying a range of 70.25 on the downside and 77.75 on the upside on Friday’s expiration.)

Implied vol in February is about 35 and should see the low 20’s after the event, so a sideways move or even slightly down puts the premium at risk. So we do need to get the move correct not only in direction but also magnitude (pop pop!).  If those sort of binary odds make you nervous, then wiggling out of the trade for a small profit makes sense. To be honest we’d prefer that the stock was closer to our long put going into the event, but we still like the risk reward of 1 to possibly make 3.50 in a stock that has shown volatility on earnings events recently.

Obviously, overall market sentiment has shifted over the past few days and that is cause for concern. But we’ve seen some disappointing results from other fast food brands lately, and we think YUM’s exposure to China makes for an interesting opportunity on a defined risk short delta structure.

I will also echo the disclaimer Dan made yesterday in our Considering Our Options post on Disney, prior to its blow out results that made our bearish trade a quick loser:

Obviously earnings trades that are directional, and utilize short dated long premium structures can be a difficult way to make a living, and I usually risk what I am willing to lose on such trades

This is a really important point when trading stocks into earnings events, and this is not for everyone and should only be done on high conviction trades.  The difference between this trade and Disney is that we legged into a very attractive risk/reward set up, and the fundamentals in YUM are confirmed to be stressed, where DIS was just too contrarian.




Trade Update – Spreading Feb $YUM Puts

Last week I bought Feb at the money puts in front of YUM’s Q4 results (due after the close on Wednesday) (read below).  With the stock down 2.5% in the last couple trading days, I can now spread the puts (that are now in the money) that I own, and reduce the premium at risk (while limiting my potential gain).  This makes sense as who knows how the stock reacts to earnings (that have been pre-announced) and guidance that I expect to be weak:

Action: YUM ($71.10) Sell to open 1 Feb 68 Put at 1.05 to open
New Position: YUM ($71.10) Long Feb 72.50 / 68 put spread for 1.00

Break-even on Feb Expiration:

Profits: between 71.50 and 68 make up to 3.50, max gain of 3.50 below 68

Losses: up to 1 between 71.50 and 72.,50, max loss of 1 above 72.50



Original Post Jan 29th, 2015: New Trade – Dim $YUM

Over the last couple years Yum Brands (YUM) has been one of our favorite short targets (most recent here) into earnings given their exposure to China, their exposure to a strengthening dollar, what seems like their ability to find themselves in almost every food recall in their key growth region in China, and generally a dislike for their a management that we think has massive credibility issues despite a weird love affair by Wall Street.

The company reports their Q4 results Wednesday Feb 4th after the close and the options market is implying about a 4% one day move vs the 4 & 8 qtr avg moves of about 4.65%.  Given the volatility environment that we are in, and some very large declines post results from some bellwethers (MSFT, PG & UPS to name a few) we like the idea of fading stocks with lots of strong dollar and large emerging market exposure:

YUM checks lots of boxes if you agree with this thesis.

Technically, $75 looks like massive resistance, with a break of $70 on news likely results in a re-test of the 52 week lows in the mid $60s:

[caption id="attachment_50401" align="aligncenter" width="600"]YUM 1yr chart from Bloomberg YUM 1yr chart from Bloomberg[/caption]

Short dated vol is moving up as expected into the print, reaching levels from the prior report, and will likely to move up a tad more:

[caption id="attachment_50402" align="aligncenter" width="600"]YUM 1yr chart 30 day at the move IV from Bloomberg YUM 1yr chart 30 day at the move IV from Bloomberg[/caption]

Analyst expect a fairly large year over year and sequential Q4 decline following the company’s mid December guide down at their annual analyst meeting (read here) which obviously speaks to low expectations.  But worse than expected results, coupled with forward guidance below street consensus for 13% earnings growth and 9% sales growth (representing a meaningful uptick from 2014), seems likely and could cause a re-rating of the shares that trade 20x expected 2015 earnings.

I want to make a defined risk bearish trade that the stock breaks down following next week’s results.

TRADE:  YUM ($72.75) Bought Feb 72.50 puts for 2.05

Break-Even on Feb Expiration:

-Profits: below 70.45

-Losses: between 70.45 and 72.50 lose up to 2.05, max loss of 2.05  above 72.50 or 2.8% of the underlying stock price.

Rationale:  Those with a directional view, options prices into the event look fair to cheap given the vol environment we are in and the way single stocks are moving post results.  Will look to spread prior to results if stock moves lower to reduce or break-even.