McDonald’s (MCD) – Grimace at Resistance?

by riskreversal November 21, 2016 12:13 pm • Trade Ideas

On Friday we detailed a bearish near term set up in shares of Starbucks (SBUX – Bean Counting) for the following reasons:

  1. its year to date relative under-performance to broad market and peers.
  2. technical set up, counter-trend rally to resistance offers attractive short entry
  3. dollar strength likely to be a healthy headwind to current qtr eps
  4. valuation trading PE/G of 2, near 10 year high.

Given what we deem to be relative cheapness of short dated options, defined risk bearish trades appear attractive.

Which leads us to another stock that cam up on a similar screen, McDonald’s (MCD), whose set up looks fairly similar from a fundamental, technical and volatility standpoint .

First, MCD is up only 1% on the year, and down nearly 10% from its all time highs made in May. I guess importantly, the stock has rallied about 8% from its 52 week lows made on Oct 21st, prior to its Q3 results. The stock this morning made a new 5 month high, but was rejected at its 200 day moving average (as SBUX was on Friday) and remains in a well defined downtrend:

[caption id="attachment_68328" align="aligncenter" width="600"]MCD 1yr chart from Bloomberg MCD 1yr chart from Bloomberg[/caption]

MCD’s dollar exposure is more pronounced in its size and geographic exposure than SBUX, with 65% of their sales coming from outside the U.S., where menu changes that stemmed same store sales declines in the U.S. last year have had less of an impact. The U.S. Dollar Index (DXY) is up about 3% since MCD issued Q4 guidance in late Oct.

Lastly MCD trades about 19x expected 2017 eps growth of 9%, which might prove to be ambitious considering sales declines are expected to accelerate to -7% from 2016’s expected -3%, which will be their third consecutive sales decline from their $28.1 billion peak in 2013 (to this year’s expected $24.6b).  The stock finds support resulting from their commitment to capital return (existing $20 billion stock buyback and annual dividend with current yield of 3.3%), even in a rising rate environment.

Short dated options prices are very near their 1 year lows, with 30 day at the money implied volatility (blue below, the price of options), while 30 day at the money realized volatility (white below, how much the stock has been moving) has risen above implieds, a fairly rare occurrence in a stock like MCD:

[caption id="attachment_68329" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

The next identifiable catalyst for MCD will be their Q4 results on Jan 23rd, but like SBUX, the recent bounce, and relatively cheap options prices could offer an attractive entry for a defined risk short biased trade.

So What’s the Trade?

Similar to SBUX we want to position for early 2017 weakness and finance that view with the sale of a put in December:

*MCD (119.25) Buy the Dec/Feb 115 put calendar for 1.70
  • Sell 1 Dec 115 put at .65
  • Buy 1 Feb 115 put for 2.35

Rationale – This trade will do well if the stock fails here at reisstance and approaches support near 115. If that’s the case the 115 put in Dec will expire worthless or can be rolled to Feb creating a vertical put spread that captures the earnings event in late Jan.