Market Sentiment (Stocks on NYSE, NASDAQ, AMEX)

Nov. 2, 2012, 12:14 p.m. EDT

Time to stop at McDonald's?

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About Andrew Giovinazzi

Andrew Giovinazzi was a member of both the Pacific Exchange and the Chicago Board Options Exchange where he made markets in both equity and index option classes. During that period he never had a down year. In 1991, Andrew started and ran the Designated Primary Market Maker post for Group One, ltd in Chicago. In 2001, he co-founded Henry Capital Management. He became Chief Options Strategist and Option Pit Mentoring in the Fall of 2011. Andrew has a Bachelor's degree from the University of California, Santa Cruz in Economics. /conga/trading-deck/bios/giovinazzi_andrew.html 230100
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By Andrew Giovinazzi

A well-known economics magazine publishes what is known as the "Big Mac Index" every year to glean information about Purchasing Power Parity (PPP) in the larger currencies. Essentially the goodies to make a Big Mac should be about the same after adjusting for currency differences, so once a Big Mac is normalized to the home currency, they should all cost about the same. But since some currencies are more expensive relative to others, Big Macs tend to cost more in overvalued currencies and cost less in undervalued currencies.

This back-of-the-envelope indicator is pretty good at predicting currencies that are too cheap or expensive relative to the dollar. It also tells us that you can get a Big Mac in just about any country in the world. Right now there is a worry about global growth, so what does that mean for McDonald's /zigman2/quotes/203508018/composite MCD -1.64% ?

McDonald's gave lower guidance this year and that helped the stock down to rock-bottom prices. If you note the charts linked below, the quick drop pushed the short-term realized volatility (white and blue lines in the lower graph) up to very high levels for a low-volatility stock like McDonald’s. The 30-day implied volatility (red line) barely registered a ripple.

MCD Vol Chart

Charts by LiveVol (r)

A closer look at the term structure (month to month IV) is showing that there is a little expectation of movement. Usually when the front-month is expensive, paper is buying options, or there has been a sharp move. The current pricing is more the latter after the big shakeout.

MCD Term Structure

Charts by LiveVol (r)

The scenario starts to play out like this. MCD is finding a bottom, but I am not sure it is there yet. Also, implied volatility is very low, low even for a plodder like Mickey D's. The term structure is interesting here because the short-term Nov. 9 weeklies are trading at a small premium to the December options. This sets up a nice time spread where you buy the back-month and sell the front-month and let the stock bounce around a little bit. The idea of the trade is to let the front-month decay and pay for a good part of the cost of the back-month. Then either hold or exit. As an example, in my opinion, the trade that looks best would be:

You could buy the MCD December 87.5 calls.

Then you could sell the MCD Nov. 9 Weekly 87.5 calls for around .70 with MCD trading at $87. Note that you would sell the November options expiring on Nov. 9.

A more bullish trade would swap our the MCD December 87.5 call and go with the MCD December 85 calls.

Disclosure: Mr. Giovinazzi has a position in MCD.

$ 244.83
-4.09 -1.64%
Volume: 580,790
Nov. 30, 2021 10:56a
P/E Ratio
Dividend Yield
Market Cap
$187.04 billion
Rev. per Employee

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