RISK AVERSION STRATEGY EXPLAINED

April 6 2010: Is Yum Becoming Overvalued? - RISK AVERSION STRATEGY NOW EMPLOYED
Yum is presently back touching the $40.00 value. The PE is at 17.84 times which is not over high for YUM but slightly higher than McDonalds 16.5X. Looking at the 5 year chart above, the stock is definitely sitting at the top of its past trading range. Earnings are stronger now than in May 2008 or October 2007 at which time the stock revisited this range. Looking at the 3 month chart below, I can see that the oversold condition has been worked out of the stock but momentum is definitely slowing. Today (Apr 6 2010) when the stock moved above $40.00, large selling volume entered, but the stock actually closed down just .24 cents or a little more than 0.60% to $39.80. With the strength of the down volume you would think this stock would have fallen at least a full percentage point if not more. In 2007 the quarterly dividend was .15 cents. In 2008 it was .19 cents and in 2009 it was .21 cents. Earnings continue to grow as does the dividend. Also, like so many USA corporations, much of YUM's debt has been refinanced at historical low levels due to the credit crisis and the historic low interest rates. This means stronger financial statements for YUM.
The answer I am trying to determine is if the stock is over valued or fairly valued. I felt at $35.00 the stock was fully valued and I had hoped to stay at $35 strike. In order to proceed with further naked puts, I would have to move to $37 strike to receive a 1% return. At $37 I am a bit concerned about a possible pullback. If you look at the 5 year chart you can see that I liked the $35 strike for puts as it is was mid-range for much of 2009. However to continue with YUM, I will have to move to the $37 strike. I will therefore reduce the number of naked puts being sold and the amount of capital being used in this trade. Unless I see a clear move by the stock to set a new range perhaps between $37 and $42, I cannot justify continuing to sell 15 monthly contracts. As well, my strategy of a reverse naked put ladder no longer can work as the advancement of the stock has reduced put premiums below the $35 strike to amounts not worthy of selling. Presently going out 4 months and staying at the 35.00 strike brings in just .50 cents which is around 0.35% per month or approximately 1.05% per year. This does not warrant even margin being made available, let alone actual capital. This means a change in strategy on YUM to a risk aversion strategy of selling only those puts that can generate at least 1% a month. This means reduced contracts, to help manage the risk of possible assignment at a higher strike than I would prefer. With a smaller number of contracts, should I be assigned at a higher price, I can continue to sell puts with additional capital, to average in at a lower price, should the stock fall.

DEC 23 2010: Reviewing the chart for the past 6 months I can see there is strong support in the $40.00 range and second support around the $46.00 level from early in the fall. The recent pullback from the highs of late fall are to be somewhat expected as the stock is a little ahead of itself. Earnings though are strong and YUM! has given forward guidance that they are expecting strong earnings in 2011 and plan to continue opening more restaurants, particularly in Asia. Meanwhile I prefer to stay around the 46.00 strike until I see firm support at $50.00 and above. I closed now for a small cost in order to roll out to Feb at the 46.00 strike and capture the higher premium. If YUM! does not fall further, into January, the Feb 46 premium will be probably half of what is now being offered. Meanwhile my Jan 45 strike is a roll up so I have already had a great January, having "double dipped" in the month. Looking at the chart below gives a good idea of how I look at a chart. I can see the support from the summer and the support in the fall. This is a typical chart of a company in an uptrend. The stock moves up, then consolidates and then move higher. It will be interesting to see if the present pullback is a consolidation before continuing the uptrend or in fact marks a high point for the present.