Pepsi Challenged

by riskreversal November 14, 2016 3:45 pm • Trade Ideas

Since last Tuesday’s close, shares of Pepsi (PEP) are down nearly 7% in a straight line. Now a lot of things have gone down since then, but probably nothing more important for a company that gets nearly 50% of its sales outside the U.S. than the U.S dollar (measured by the DXY) rallying nearly 4.5% from its Wednesday morning lows, now nearing the high end of the 52 week range:

DXY since Sept 2015 from Bloomberg
DXY since Sept 2015 from Bloomberg

Obviously it’s not just the move in the dollar that has caused the near term weakness in PEP, but investors rotating out of what was once deemed defensive sectors like Consumer Staples with high dividend yields into more economically sensitive sectors like Industrials that might benefit from an increase in fiscal spending, or Bank stocks which will benefit from the de-regulation of Wall Street in the Trump administration.

And then most obviously, the historic rise in interest rates since Tuesday has investors rethinking a bit what they are paying for yield in a period where buybacks may also lessen. PEP is not exactly a cheap stock trading 21x expected 2017 eps growth of 8%, but the stock’s recent 10% decline from all time highs has placed the dividend yield at 3%.

From a technical standpoint, the stock is at an inflection point. For the last year $100 has served as healthy support, but it is now also approaching the uptrend that has been in place since early 2012:

[caption id="attachment_68144" align="aligncenter" width="600"]PEP 5yr chart from Bloomberg PEP 5yr chart from Bloomberg[/caption]

Short dated options prices are nearing pre-earnings levels on the sell off, possibly providing an opportunity for long holder to add yield through over-writes, or those looking to play for a rebound with a short vol strategy, or a break-down using calendars:

[caption id="attachment_68145" align="aligncenter" width="600"]PEP 1yr chart of 30 day at the money Implied Volatility from Bloomberg PEP 1yr chart of 30 day at the money Implied Volatility from Bloomberg[/caption]

So What’s the Trade(s)?

Yield Enhancement:

For those that are already long PEP, selling one Dec30th 105 call at about 70 cents (stock reference 101.30) against 100 shares could make sense to add some yield for the next 45 days.

Long Alternative:

For those looking for stock alternatives or replacement with defined risk, the the Dec 100/105/110 call fly is 1.65 and is like buying stock just above the level it’s trading now while only risking 1.65 total in case the stock is unable to hold.

Put Calendars:

The last trade idea to take advantage of the vol spike is to finance for further weakness by selling near term puts. The Dec/Jan 95 put calendar is only .60 and would do great if the stock was unable to hold the 100 level and headed towards 95 by Dec expiration. Jan also captures the next earnings.

Another version of that trade would be to sell a tighter put but closer. The Nov/Jan 100 put calendar is 2.25 right now and once the Nov 100 put expired you could roll that to December.