Event: McDonald’s (MCD) reports Q3 results next Friday prior to the open. The options market is implying a 2.75% weekly move between now and next Friday’s close (most of which is for the event move, lets call it 2.5%). With the stock at $115, the Oct 21st 115 straddle (the call premium + the put premium) is offered at $3.15, if you bought that, and thus the implied weekly move, you would need a rally above $118.15, or below $111.85 to make money by next Friday’s close. The average one day move over the last 4 qtrs has been 3.375%, which included last quarter’s 4.5% one day post earnings decline, and the year ago 8% one day rise after reporting Q3 2015 results.
Price Action / Technicals: after being one of the best performing stocks in the Dow Jones Industrial Average in 2015, the stock has under-performed ytd down nearly 3% vs the index up 4.25%, but more importantly, MCD is down 13% from its 52 week and all time high made in May.
The stock is hovering just above near term technical support at $112.50 (an intra-day 2016 low made last week), a sort of most hold level down to $110, below that there is an air-pocket down to the Q3’15 breakout level back near $100:
Taking a 5 year view, the breakout above a multi-year consolidation was predicated on a management change, corporate restructuring and drastic menu changes that resulted in a massive sentiment shift yielding 30% gains in less than a year:
Despite eps expected to be up double digit this year for the first time since 2011, sales are expected to decline for the third consecutive year. Which leads me to the company’s commitment to capital return (existing $20 billion stock buyback and annual dividend with current yield of 3.3%) which has added eps, and caused demand from investors seeking yield. MCD trading at nearly 21x 2016 and nearly 19x expected 2017 eps seems fair given the yield, and now the stock’s decline from the recent highs, but its important to consider the potentially adverse affect from the recent strength of the U.S. dollar as two thirds of their sales come from outside the U.S. and they will be running up against difficult comparisons since their all day breakfast took effect a year ago.
Given all that, it might make sense for long term holders to consider collar their stock into what could be a potentially volatile event, and increasingly volatile broad market. And at the every end I’ll add a straight overwrite for those who are not too worried about a sharp decline, but think the stock could be range bound and like the idea of adding yield.
So what’s the trade?
There are two ways you might want to protect your long stock one in Dec and one in Jan expiration:
Against 100 shares of an existing long in MCD at $115, buy Dec 120-110-100 Put Spread Collar for 40 cents
-Sell 1 Dec 120 call at 90 cents
-Buy 1 Dec 110 put for 1.70
-Sell 1 Dec 100 put at 40 cents
Break-even on Dec Expiration:
Gains of the stock between $115 and $120, less the 40 cents premium paid for the structure. If the stock is 120 or higher you would need to make a decision about covering the short call, or risk being called away. The stock will trade ex a 94 cent dividend on Nov 29th, which is paid on Dec 15th.
Losses of the stock (plus 40 cent premium for the trade structure) down to 110, protection of up to $10 between $110 and $100, no protection below.
OR Just a straight collar into the new year.
Against 100 shares of an existing long in MCD at $115, buy Jan 120 / 105 Collar for 15 cent credit
-Sell 1 Jan 120 calls at $1.45
-Buy 1 Jan 105 put for 1.30
Break-even on Jan Expiration:
Gains of the stock up until $120 (plus the 15 cent credit). If the stock is 120 or higher you would need to make a decision about covering the short call, or risk being called away. The stock will trade ex a 94 cent dividend on Nov 29th, which is paid on Dec 15th.
Losses of the stock down to $105, protection below.
OR for yield enhancement…
Against 100 shares of an existing long in MCD at $115, Sell the Jan 120 call at $1.45
Gains of stock up to $120 on Jan expiration, plus the $1.45 in premium taken in resulting in a call-away level of $121.45, up 5.6% in 3 months.
The $1.45 in premium for the call sale creates a small buffer for losses down to $113.55, and the stock will trade ex a 94 cent dividend on Nov 29th, which is paid on Dec 15th.