We previewed YUM this morning ahead of its Q3 earnings on Tuesday afternoon. Feel free to read the whole preview, since this is a company that has had an interesting experience in China over the past year. For you slackers though, here was our conclusion:
This is one of the better-valued stocks in the restaurant space. If YUM shows progress on the Chinese turnaround, then we see the potential for a breakout to new all-time highs in the next few months. We might look for a way to participate that does not leave us exposed to decay.
This quarter’s earnings is crucial to the overall story, but in our view, the market’s expectations are low overall, especially relative to YUM’s peers. With that in mind, here’s the structure we like:
NOTE: WE HAVE NOT TRADED THIS STRUCTURE YET, BUT WILL POST IF WE TRADE IT BEFORE EARNINGS
TRADE: YUM ($70.80) Sell the Nov 67.5 / 65 Put Spread, Buy the Nov 75 Call, Even Money
-Sell 1 Nov 67.5 Put at 1.18
-Buy 1 Nov 65 Put for 0.58
-Buy 1 Nov 75 Call for 0.60
Break-Even On Nov Expiration:
-Profits above 75 in linear fashion
-Losses of up to 2.50 between 67.5 and 65, max loss of 2.50 below 65
Trade Rationale: We are not trading this today, but we like this structure, especially if YUM trades down to between 69 and 70 before earnings. The company has expressed optimism about Chinese results for the second half of 2013, so earnings could be a catalyst to lead to a breakout to new all-time highs above 75 on a strong number. Given YUM’s consistency over the past decade, and its decent valuation, we like the risk/reward of this structure. For now though, we’re watching the stock.