Name That Trade – $KRFT: Whiz With

by Dan March 11, 2015 3:26 pm • Commentary

Earlier today (here) I detailed some unusual call activity in Kraft Foods (KRFT) yesterday:

Yesterday, when the stock was $61.45 a trader paid .70 for 10,000 June 67.50 calls to open. These calls break-even on the upside at $68.20, up 11%, which happens to be a tad above the recent all time highs.

This prompted me to look at the recent price action in the stock.  The breakout late last year to new all time highs on massive volume was a thing of beauty as investors cheered management changes and the potential for a new strategic plan.  While the break-out was a work of art, the subsequent re-tracement of the gains has the potential to mark a long term top for the shares:

KRFT 1yr chart from Bloomberg
KRFT 1yr chart from Bloomberg

If you think that recent pull back to the breakout level is an attractive long entry spot, buying three month and 11% out of the money calls is probably not the way to go to express this bullish view.

Options prices have been picking up of late as the stock has sold off and overall vol has been ticking up in the market.  Thirty day at the money implied vol is reaching levels that warrant the consideration of spreads or even flies for those looking to express directional views:

KRFT 1yr at the money IV chart from Bloomberg
KRFT 1yr at the money IV chart from Bloomberg

Regular readers know that I have been pretty vocal about valuation of “defensive” stocks and sectors leading up to the recent highs, and think the recent price action in high yielding sectors like Utilities, Reits and Consumer Staples is rational given the low growth profiles for most, and in the case of Staples heavy exposure to dollar strength.  

KRFT falls right into that camp but with one big difference. The potential for restructuring and m&a as the new ceo sets a new course. Paying 18x expected earnings growth of 3% on expected sales growth of only 1% in 2015 seems a bit silly, with much of that premium likely related to the 3.6% dividend yield on the stock. And with the stock down 10% from last month’s highs, its easy to see how silly things were getting and how off-sides some investors have been.

All that aside, $60ish could be a decent long entry for a trade.

I am going to be a little patient here, as this sort of selling has the potential to overshoot on the downside, but as one large player was looking out to June and buying the 67.50 calls, I might be inclined to use that strike as the short leg of a call spread. Gun to my head, this is the bullish trade I choose:

Hypothetical Trade: KRFT ($61) Buy June 62.50 / 67.50 call spread for 1.20

-Buy 1 June 62.50 call for 1.85

-Sell 1 June 67.50 call at .65

Break-Even on June Expiration:

Profits: up to 3.80 between 63.70 and 67.50, with max gain of 3.80 above 67.50

Losses: up to 1.20 between 63.70 and 62.50 with max loss of 1.20 below 62.50

Rationale: Pretty decent risk reward for an out of the money call spread with plenty of time to play out. There’s some other options closer in that play for a bounce but I like the idea of buying some time here for the stock to get back to those recent highs. I’ll be keeping my eye on it, especially if it holds that $60 level.