Options Update: Is a Straddle the Best Way to Play Kraft?
Delicious Earnings News
Yesterday, Kraft Foods
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PowerRating) announced its quarterly earnings report – to the delight of the Street. In the wake of yesterday’s news, KFT finished the day nearly 5% higher. Today, UBS saw fit to reiterate its “neutral” rating on the stock, but it has had little impact on the cheese champ’s price action. KFT is less than a percentage point higher today following the brokerage’s decision.
Nevertheless, the 2-day rally has energized investors and option players alike as far as KFT is concerned. The macaroni madman rests atop the call activity and near the top of put activity; it is this action that has caught my eye today.
According to today’s Intraday Volume Explosion List, KFT may be the subject of a few straddle plays. On the call side, KFT has seen total daily volume ramp up nearly 17 times the norm – with most of the activity falling on the August 35 contract (KFT HG). Volume for this contract checks in at 131,710 contracts, comprising a majority of the day’s total call volume of 182,041. Turning to puts, total volume jumped slightly more than 16 times the daily average, with all but 1,000 (or so) contracts crossing on the August 35 put (KFT TG). One can see why we may assume a straddle here, as we have an unusual amount of activity taking place on corresponding put and call contracts.
Drilling down on the activity, it appears that most of the day’s action took place in 2 major transactions (for both the put and call). At 10:06 a.m. Eastern, a block of 50,000 contracts crossed on both the put and the call. Both of these transactions went off near the ask, suggesting that the hypothetical purchaser opened a straddle. As for the other transaction, it occurred shortly after noon Eastern time, with a block of 50,000 crossing between the bid and ask for KFT TG and a corresponding block of 50,000 for KFT HG going off at 2 cents per contract.
Let’s look at how much our hypothetical purchaser would have paid. For the earlier transaction, it would have cost a staggering $22,250,000 to purchase the 50,000 KFT TG contracts ($4.45 apiece) and $250,000 to purchase the corresponding call. The later transaction cost $20,600,000 for the put and $100,000 for the call. Now, for these transactions to break even, KFT would have to fall past $30.55 or advance past $35.02 (for the earlier transaction) and drop past $30.88 or rally past $35.05 (the later transaction).
Spoiled Sentiment
Analysts are sour toward KFT, as brokerage houses dish out 2 “strong buys,” 1 “buy,” 10 “holds,” and 1 “strong sell.” This configuration leaves the door wide open for upgrades, which could help push the stock higher.
Similarly, option players skew toward the bearish end of the sentiment spectrum. KFT’s Schaeffer’s put/call open interest ratio (SOIR) of 0.97 is higher than 82% of those taken during the past 52 weeks. In other words, option speculators have been more bearish toward KFT just 18% of the time during the past 52 weeks. This collection of bearish bets could help push the stock higher should good news continue to roll in for KFT.
Yummy Performance?
Let’s remember where our hypothetical straddle purchaser needs KFT to reach in order to break even on today’s transaction. The furthest north the stock needs to advance is $35.05, while it has to drop past $30.55 on the low end.
What are the prospects for such a move?
With the stock trading at $31.22, it certainly seems that the low end of the “break-even” range is the likeliest to fall. The good news here is that there is ample overhead pressure to push the stock lower. KFT has failed to top its descending 10-month and 20-month trendlines since November, and it appears that this trend should continue.
Why am I so confident that our hypothetical purchaser will make money thanks to the puts? There is the aforementioned resistance, but there is also the fact that the stock is range bound. Watch for the stock to retreat from this overhead resistance, a retreat that could take it all the way back to the 28 level. If this happens, our option player could turn a nice profit on his/her puts.
Why dish out the extra money on the calls? Notice that a run to the upper rail of the trading range would move the calls into the money. Let’s call it insurance. Seriously, the price paid for the calls was a mere drop in the bucket compared to the money dished out on the puts. I suppose that our hypothetical option player was hedging his/her bets.
The Verdict?
Remember that a straddle player is looking for a sizable move in either direction. Is that possible with KFT? Yes, but I think the smart money is on the drop into the lower 30 region, making the puts profitable. While the sentiment could push the stock higher, I think the overhead resistance may be too much for the stock to handle.
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