With Earnings Old News, Can McDonald’s (MCD) Move Higher?

McDonald’s (NYSE:MCD) had an intraday reversal yesterday, losing ground in early trading before recovering back into positive territory, thanks to its fourth-quarter earnings report. Ahead of the open, the fast-food giant said it collected $1.16 per share in profits, matching the consensus view. Revenue rose 4% on a year-over-year basis to $6.2 billion, also in line with what analysts were expecting.

In the conference call that accompanied the earnings figures, MCD said it is well-positioned to invest in its business. The company plans to invest $2.5 billion of capital to build 1,100 new restaurants and give a face lift to many existing locations.

For the current month, MCD expects global comparable sales to increase 4% to 5%. Its breakfast dollar menu has been strong, the introduction of fruit smoothies has been successful so far, and the McCafe coffee drinks is having a positive impact on the international breakfast business.  They say beef is currently their most volatile cost, so who knows, they may borrow from fellow fast-food brand Chick-fil-A and encourage customers to “Eat Mor Chikin [sic].”

Wall Street is fairly optimistic toward Micky D’s, with 15 of the 22 covering analysts rating the stock a “buy” or “outperform” – according to the OptionsHouse research tab. There are currently no “sell” ratings on the stock.  The stock has lost 4% in the last six weeks, retreating from its early-December peek above the 80 level, but perhaps MCD bulls expect this pullback to be short-lived.

Investors who may think about an alternative to buying or selling MCD stock outright could consider option strategies such as the ones we have outlined below. One strategy is for bulls and one is for bears, and both are for educational purposes only – you must consider your own investing goals and risk tolerance before undertaking any new strategies.

Prices below were taken Monday afternoon.  MCD stock was trading at $75.29, up 28 cents for the session.

Bullish Option Strategy: Covered Strangle

This strategy combines long stock with a short strangle for a bullish strategy that should benefit from a move higher in the shares. The stock has a quarterly cash dividend of 61 cents per share (the ex-date of which is February 24). For simplicity’s sake, let’s say the trader in this example bought 100 shares for $75 apiece (a net investment of $7,500).

On top of this, he sells the March 75/80 strangle (shorting both the March 75 put and March 80 call) and collects a net credit of $2.03 ($203 per lot).  This is roughly 2.7% of the stock price and can be thought of income enhancement for the overall strategy.

The maximum profit, should MCD be trading above $80 at expiration, is $7.03 per strategy.  This is the credit collected for shorting the strangle ($2.03) plus the gains in the stock from $75 up to $80.00. Gains begin to deteriorate below the $80 strike until breakeven of $73.98.

Calculating breakeven gets a little complicated on this strategy because the position is double long below the short put strike:

(Stock price + Put Strike – Net Credit )/ 2

Risk is significant but technically limited as MCD shares cannot decline below zero.  Below the put strike (75), the position is long 200 deltas so this trade should only be entered into if you are willing to purchase more shares at the short put strike.

Charts were built with the OptionsHouse profit/loss calculator. This is one of the tools investors have access to as part of a virtual trading account. Use this tool to illustrate how the profit/loss relationship changes due to movements in the stock price, implied volatility, or other factors.

Bearish Option Strategy: Put Butterfly

Those who are not MCD fans could consider a bearish option strategy such as a put butterfly.  The February 70-72.50-75 put butterfly spread – buying one 70 put, selling two 72.50 puts, buying one 75 put – can currently be purchased for a net debit of 51 cents per spread.

If MCD is trading right at the short strike (72.50) when the options expire, profit is the difference between the higher-strike long put strike and the short strike – 2.50 – less the debit paid, or $1.99.  Breakevens for this strategy are $70.51 to the downside (the short put strike less the maximum profit) and $74.49 to the upside, or the higher-strike long put less the premium paid.  If MCD is trading anywhere between these levels when the options expire in four weeks, the trade will be profitable.

Losses are capped at the premium paid ($0.51) on both the upside and the downside as the strikes are evenly spaced from the short strike.  Return on risk is potentially 390%; MCD would need to drop 3.7% from its current price in less than four weeks in order to hit the 72.50 strike by February expiration.

 

Photo Credit: Like_the_Grand_Canyon

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