YUM Drops a Drumstick

02/08/2013 8:00 am EST


After wowing analysts and retail investors alike by its rapid expansion into China, this global fast-food giant seems to have stumbled in recent months, and Andrew Giovinazzi of OptionPit.com offers a trade idea based on its resurgence.

After my post on Friday I was feeling pretty good about the state of implied volatility for the short term. Then I woke up on Monday and the Europeans upset my apple cart. Was it 2012 again? So Tuesday everyone needed an excuse to sell and we had a short-term pop in the VIX only to be erased by the up move Wednesday. From a volatility point of view, the up move was more violent than the down move Tuesday. In general when two directions (up or down) are in play the IV tends to hop up. What happens when the market takes one side out of play? That is the YUM (my) trade of the day.

I was on the bubble about Moody’s (MCO) or Yum! Brands (YUM). The reason being both names have what I call a ‘lid’ on them. I will skip MCO but you will get the idea. YUM reported Monday and they were clearly hurt by the flap about the super, bionic, GMF chickens. Earnings got dented and what has been a fantastic growth story is getting upended in the short term. No problem, but the question is what side of the market is getting “taken out” by the news? If one side is taken out of the equation, it is vastly easy to position. I think at this point the downside move is sort of done. YUM is well off its highs and the growth most likely will resume. In the meantime, it is kind of a wounded duck, which should take some of the heat off of its movement. Once I put together less movement and minimal downside risk I look for time spreads. The volatility risk after earnings is relatively small since it has already been marked down.

The only real question is duration and strike now.

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For YUM, I would keep the duration relatively short. When I looked at the trade Tuesday afternoon, there was still some volatility edge between Feb and Mar. Ultimately a long-time spread is just a modified front spread and it might take a while for the market to really like it again. If they can put 5,000 outlets in China, they can easily put 10,000.

The Trade
Either a long YUM Feb/Mar 62.5 calls spread or the Mar/Apr 65 call spread, depending of course, on how much you love Taco Bell and KFC.

I have similar YUM positions, and I am still short some volatility via the VIX.

By Andrew Giovinazzi, Chief Options Strategist, OptionPit.com

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