With an ambiguous market and economic environment ahead of us, it’s not entirely unreasonable for bearish traders to move against fast-food giant Papa John’s (PZZA). True, debates about whether or not a recession may materialize next year continue unabated. However, it’s safe to say that the prospect of a downcycle represents a non-zero-probability event.
As Barchart contributor Ilir Salihi mentioned, there are more than enough pieces of evidence to warrant at least investigation into the matter. Further, PZZA stock isn’t doing any favors when it comes to inspiring confidence. Since the start of the year, shares stumbled almost 15%. In addition, the company didn’t exactly warm Wall Street’s heart when it disclosed its results for the third quarter.
On the top line, Papa John’s rang up sales of only $522.8 million, conspicuously missing analysts’ consensus view of $530.3 million., On the bottom line, the fast-food joint posted non-GAAP earnings per share of 53 cents. This figure also missed the analysts’ target, in this case for EPS of 57 cents. Pouring salt was a free cash flow print of $17.1 million, down 53.4% from the year-ago quarter.
As StockStory points out, PZZA stock benefits from the broader narrative of fast-food restaurants: speed and convenience. However, this narrative also clashes with contemporary sensibilities. “This class of restaurants, however, is fighting the perception that their meals are unhealthy and made with inferior ingredients, a battle that's especially relevant today given the consumers increasing focus on health and wellness.”
Subsequently, it’s not terribly surprising to see an institutional trader (or traders) bet against PZZA stock with sold call options. However, this might be a risky wager for the bears.
Sold Calls Send a Signal to the Bulls
Watch any zombie movie and chances are, you’ll find its main protagonists in a critical dilemma. They may have discovered a cache of firearms and are therefore able to protect themselves. However, discharging a gun is obviously a cacophonous action. They may save themselves from a bind at the moment but they’ll likely attract other zombies.
In a way, a sold call – particularly if an institutional trader is underwriting the risk – is very much like discharging a firearm during a zombie apocalypse. Astute bulls will almost certainly pick up on the activity, especially if it’s anomalous enough to end up on Barchart’s screener for unusual stock options volume. That was the case for PZZA stock last Friday.
To understand the dilemma the bears face, investors unfamiliar with options trading should check out this half-minute video I produced. Essentially, a call option is a contract like any other: one party agrees to provide something of value and the countervailing party pays for the underlying product or service.
That’s critical to understand because investors generally know that call option holders have the right but not the obligation to buy the underlying security at the listed strike price. However, on the other end of the contract, a call seller (writer) has the obligation but not the right to fulfill the terms of the contract; in a call option’s case, to sell the underlying security at the agreed-upon strike price.
Now, call writers agree to underwrite such a risk because they get paid to do so in the form of the premium; a premium is the price a buyer pays to acquire the option. At face value and assuming no complex, multi-tiered strategies, a call writer is betting that the underlying stock doesn’t rise above the listed strike price. On the other hand, a call buyer is betting that it will.
Since no upside price limits exist for a stock, if the call writer doesn’t own the security in question, it could lead to a panic.
PZZA Stock Risks a Gamma Squeeze
Now, for PZZA stock options specifically, they represented one of the most aberrant trades on Friday. Total volume reached 3,541 contracts against an open interest reading of 24,836 contracts. Against the trailing one-month average volume, Friday’s metric resulted in a delta of 244.46%. Interestingly, call volume hit 3,529 contracts against put volume of only 12.
On paper, we’re talking about a put/call volume ratio of 0.003, a practically infinitesimally small figure. At a cursory reading, this ratio implies that more traders are engaging call options relative to puts. However, Fintel’s options flow screener shows that on the Nov. 24 session, an institutional trader sold 3,500 contracts of the Dec 15 ’23 72.50 Call.
In my opinion, that’s a risky wager. Yes, the risk underwriter has three weeks since the placement of the trade for the call to safely expire worthless. Also, Papa John's doesn't offer the most convincing business, as I remarked last month. Still, the gap between the strike and Friday’s closing price is only 7.5%. A couple of robust sessions and the call writer could start sweating.
Indeed, Papa John’s Q3 print wasn’t completely terrible. For instance, its gross margin stood at 30.2%, up from 29.6% against the prior-year quarter. In addition, same-store sales jumped 2.2% on a year-over-year basis. Even if recessionary pressures materialize, that may benefit the cheap and convenient narrative of the fast-food industry. Thus, PZZA stock could be due for a gamma squeeze.
A gamma squeeze usually materializes in near-expiry call options as the bears suddenly get caught out as the targeted security starts to rise unexpectedly. Suddenly, those three weeks could be the longest that the call writer ever endured.
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