Tyson: Going In For the Knock Out

Mike Tyson has been credited with several knock outs in his infamous boxing career. It looks like the other Tyson, Tyson Foods Inc.,
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may have received a knock out punch yesterday, after reporting a whopping decline in third quarter profits of 92%.

Rising grain prices combined with decreasing chicken breast meat prices created the perfect environment for a slump in the stock price. In addition to the current bad news, even Tyson’s CEO Richard Bond is not optimistic about the future. He told a conference call yesterday, “Our chicken segment won’t be positive in the fourth quarter and its losses may be greater than the third quarter. If grains stabilize, Q4 could be the worst quarter in this cycle for our chicken segment”.

The institutional traders of credit default swaps have reported that swaps have gained 30 basis points to 288. This indicates that the price of protecting bondholders from total company default is increasing. When the swaps rise in price, it means the credit worthiness of the company is thought to be decreasing. It’s not just chicken that is Tyson’s woes, their beef unit’s operating profits fell 92% and the profit from prepared foods collapsed by 77%. It seems that Tyson has fallen on bad luck, capped off with $7 million of flood damages at its Jefferson, Wisconsin plant, as an addition kick to the struggling company.

But, there is some good news on the profit front for Tyson. The pork unit posted 46% gains in profits due to strong export sales and dropping hog prices.

Tyson Chart

Now that the basic fundamentals of the Tyson situation are laid out, is their further downside, or has the bad news already been priced into the stock? Today, Tyson TSN has bounced off of its lows yesterday and has started to flatline between $15-15.40/share. How would an option trader play his bias on this stock with extremely bad news and poor company projections already released?

Let’s take a look at several simple option strategies depending on your bias right now. I am assuming a $2000.00 risk amount and a 6 month time horizon on these tactics.

Bearish

If you think Tyson truly received a “knock out punch” and will continue its downward slide, a Bear Call Spread may be the way to go. Here is an example:

Buy 12 January 2009 17.5 calls TSNAW at the current price of $1.20 and sell 12 January 2009 15 calls TSNAC at the price of $2.10. The table below (courtesy of optionsxpress) shows the profit/loss at different prices of the stock.

Bearish on TSN Chart

Neutral

If you think Tyson has already taken the big hit from all the negativity and will simply flounder around the current levels, a Short Straddle may make sense. It is critical to note that the maximum risk on this strategy is theoretically unlimited, so watch the position closely. Here is an example:

Sell 3 January 2009 17.5 calls TSNAW at $1.05 and sell 3 January 2009 17.5 puts TSNMW at $3.00. Here’s the expected results based on the stock price:

Neutral on TSN Chart

Bullish

This bias will mark you as a true contrarian trader. Remember, in this game, the greatest rewards go to those who take the most risk. When things look the bleakest is when the most money is made by going against the herd. Here is an option strategy to play the bullish side. Simply buying the January 17.5 calls TSNAW at $1.20 is a way to play your bullish bias and contrarian nature on Tyson. Here is the breakdown of buying the calls. As you can see there is huge upside should the stock have bottomed and climbs above 25 and your downside is limited to the price spent for the calls.

Bullsih on TSN Chart

Regardless of your bias on Tyson Foods, there is an effective option strategy to implement. Remember that all option trading involves risk, use only capital that you can afford to lose, no matter how strongly you feel.

Best Wishes!

David Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.