Considering Our Options: $YUM Feb Put Spread

by Dan February 5, 2015 10:30 am • Commentary

YUM released Q4 results last night that were below consensus, but generally in line with re-set expectations. The company expects China weakness to continue and the “pace of the recovery is slower than expected”.  The company said they are “committed to 10% eps growth in 2015”.  This seems hopeful for a company that has not achieved this goal for the last two years.  The company suggests that a rebound in China in the second half of 2015 will be the impetus for double digit eps growth.  I view this guidance as squishy at best.  I am shocked the stock is up. It is my view that management has a massive credibility problem and after listening to the Q&A on the conference call the company is doing their best to put lipstick on a pig.

Here is our current position after legging into a put spread last week:

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

With the stock up on the day (about 1% at $74.50 as I write) the put spread has lost about half of its value, but the stock has been all over the place and ealrier when the stock was down on the day, the trade was a slight winner. So with 2 weeks to expiration I still very much like owning the $72,50 put strike.  We might consider closing the short leg of the put spread if it were offered at .10 or less.  And I might even consider rolling out this bearish view. It is my opinion that any near term improvement the company has seen is based on aggressive promotions and advertising and a revamp of menus in China. On the call, analysts were not satisfied with the company’s answers regarding the recovery in China.  I suspect we see disappointed commentary from the Wall Street analyst community as they write up the results over the next day or so.

For the moment, I am wrong on direction, but remain committed to the thesis, so the decision I have is to roll up and out the strikes, or stick with what I have.  I will make a decision after the call, once the stock establishes



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.