Trading options against stocks that are suddenly out of favor can be hit and miss. Sometimes trading options on such stocks provides substantial gains and other times, there are losses. On Friday YUM Stock fell again on worry that China’s economy was slowing down. McDonalds Stock fell as well since its latest earnings report showed weakness in Asia and McDonalds issued a warning about China’s slowing economy possibly impacting McDonalds earnings. This hit YUM Stock hard as Asia is where YUM Brands has a lot of earnings. They are also aggressively opening restaurants in China and India. They are far more aggressive than McDonalds in Asia.
Investors worry constantly. They hate unknowns. Readers might recall that on June 4 the same thing happened to Yum Stock with investors dumping shares. This was my first purchase of Yum Stock in a while and on Thursday I sold my shares. You can read that Yum Stock article through this link. Today investors mood changed and they dumped shares again and Yum stock fell to $62.37. I decided to try something a little different here. I entered into a trading options strategy on Yum Stock.
200 Day Moving Average
Yum Stock is back to the 200 day moving average and during trading on Friday it fell below the 200 day moving average but managed to close above it. This is the second time Yum Stock has fallen to the 200 day moving average in just 4 trading sessions. Using my early warning tools as explained in my article on Spotting A Collapsing Stock, Yum Brands still does not exhibit the signs of a stock about to collapse. However the constant test of the 200 day moving average is a concern and it may finally break which would be negative longer term.
Trading options on YUM Stock at these levels makes a lot of sense. For a small costs I can control 1000 shares with limited risk.
Yum Stock Technical Timing Outlook
Two technical timing tools worth paying attention to with Yum Stock are MACD (Moving Average Convergence / Divergence) and the Ultimate Oscillator. Friday’s readings are below and you can see that MACD is warning that there is more selling ahead for YUM Stock. However the Ultimate Oscillator continues to rise as Yum Stock is falling. This is clear evidence there is a lot of buying going on in the stock at these levels. Whether this buying can continue is the big question but I have a lot of faith in the support zone of $57.50 to $60.00 in Yum Stock which is why i entered into my Trading Options strategy on Friday.
Yum Stock Technical Timing Tools readings for Friday June 8 2012
Yum Stock Trading Options – Calls
I could have bought the stock but I felt that call options might return the biggest bang this time around. The June $60.00 call option expires in one week and so I bought it for $3.35. This was quite a fall from Thursday when the call option was trading for $8.05.
This Trading Options strategy is certainly not for everyone. I did just 10 call contracts and I also sold 10 naked puts for July $57.50 for a whooping $1.25 which turned out to be the high for Friday.
Yum Stock Trading Options – Buying Some Protection
The second step is to buy some protection. This is just a one week trade and I am just looking for a pop in the stock to push up my call options. To reduce my cost on these call options I turned my trade into a credit spread and sold the July $67.50 calls for $1.59. This reduces my call options from $3.35 to $1.76. I then sold the $57.50 July puts for $1.25 which further reduces my cost for the July $60 calls to just .51 cents.
Review Of Yum Stock Trading Options Strategy:
Bought 10 June $60 Yum Stock Call Options for $3.35
Sold 10 July $67.50 Yum Stock Call Options for $1.59
Sold 10 July $57.50 Yum Stock Put Options for $1.25
Total cost for my Yum Stock $60 call Options = $0.51 cents.
Total cost for this trade = $510.00 (all figures are without commissions)
Trading Options Strategy Explained
To understand this strategy and why I would use it, consider trading options versus holding the stock. The total cost for this trade is $510.00. The stock needs to stay above $60.51 in order to be profitable. But for me to do this same trade with Yum Stock versus trading options, I would have at risk a little over $63,000.00. If the stock should jump perhaps $1.00 I would earn $1,000 or 1.5%. If though the stock should stay around $62.50, I will earn $2000 but invested just $500.00.
If the stock fell to $60.00 and I wanted out of this Yum Stock trading options positions, my loss will be $510.00. If instead of the trading options positions I had just bought stock and sold my Yum Stock at $60.00 my loss would be $3000.00.
Pitfalls With The Trading Options Strategy
There are of course pitfalls with every trade. Since I purchased my protection into July, this will reduce my profits if I have to close the July $57.50 Puts or July $67.50 Calls prematurely.
However since Yum Brands is a stock I like, trading options in this fashion does not concern me. If the stock falls to $57.50 I would roll out but perhaps not down because I believe $57.50 is a decent price for Yum Stock. On the other hand should the stock stay around the $63.00 level I may not close but hold my $60.00 calls and roll into July or perhaps even August.
Distinct Advantages of Trading Options Rather Than Yum Stock
This trading options position allows me to control 1000 shares of Yum Stock for a fraction of the risk associated with having over $63,000.00 of capital tied to Yum Stock. Basically for $510.00 I am controlling a trading range in Yum Stock based on the support and resistance levels I selected in previous articles on Yum Stock.
By purchasing my call options and setting up this trading options strategy for a short-term trade of just one week, I have a lot of options still available to me and because I would pick up shares I have a lot of confidence in my positions. At $57.50 owning Yum Stock would be a decent entry point.
Effectively then I am in Yum Stock with 1000 shares at a cost basis of $60.51 and my total loss on this trading options position will be $510.00 should the trade fail. This is a pretty sweet spot all thanks to investors concern about China and prospects for Yum Stock in the coming months.
To view Yum Stock Options select this Trading Options link.
To view YUM Brands Investor Latest News select this Yum Stock Link.