Happy Friday, everyone.
Last night, the Jets ran all over the Patriots in the NFL's first game of week three. All-star QB Aaron Rodgers finally came to play, pitching two TDs, 281 yards passing, a 77% completion rate, and a healthy 118.9 passer rating.
If you’re a Jets fan, I'm sure it was fun to watch. However, if you had my fantasy team, you’d be pulling your hair out right now. An 0-3 start in head-to-head isn’t a best-case scenario. But I digress.
International Flavors & Fragrances (IFF) had two unusually active call options in Thursday trading -- defined as Vol/OI of 1.24 or higher and expiration dates of seven days or more -- and this relative options newbie thinks he’s spotted a diagonal spread worth investor consideration.
The question is whether investors should jump on board IFF stock. Here are my thoughts.
Have an excellent weekend!
The Diagonal Spread Explained
I won’t pretend that the diagonal spread is part of my limited options vocabulary, which is far from it. I noticed the two calls while checking out yesterday’s trading and asked Perplexity a question.
“Is there a name for buying two calls of the same stock at different strike prices and expiration dates?” I asked.
It answered.
“Yes, there is a name for buying two calls of the same stock at different strike prices and expiration dates. This options strategy is commonly known as a ‘calendar spread’ or ‘time spread,’” Perplexity responded.
However, when I asked Perplexity the difference between a ‘calendar spread’ and a ‘diagonal spread,’ it confirmed that my example from the intro is, in fact, the latter.
Where it gets dicey is that it’s generally recommended that the separation between the two expiration dates be no more than 6-12 months. The above are right at a year. Additional risk creeps in for longer separations, but that’s a subject for another day.
The Play Itself
Okay, so to execute the diagonal spread, you would buy the Jan. 16/2026 $110 call and sell the Jan. 17/2025 $95 call. This is considered a bearish stance on IFF stock because the longer-dated $110 call has a strike price higher than the shorter-dated $95 call. For a bullish stance, you would flip the strike prices.
So, if you like IFF stock, you’ll want to find either a longer-dated call with a strike below $95 or a shorter-dated call with a strike above $110.
Now, let’s consider each of the two calls separately.
The short-dated call expires in 121 days on Jan. 17/2025. Your premium by selling the naked call is $1,100. Your breakeven share price is $106 ($95 + $11). Your maximum risk above $106 is unlimited. Your maximum return is $1,100.
The long-dated call expires in 485 days (a little over 16 months) on Jan. 16/2025. Your cost for buying the call is $1,250. Your breakeven share price is $122.50 ($110 + $12.50). Your maximum risk is $1,250. Your maximum return above $122.50 is unlimited.
If IFF’s share price is $106 in January, you’ll break even on the short call. Meanwhile, based on the 0.52028 delta of the long call and yesterday’s closing price of $103.24, the ask price should be approximately $1.44 (11.5%) higher ($106 - $103.24 times $0.52028).
If IFF’s share price is $90 in January and out of the money, you’ll get to keep the $1,100 premium from selling the naked call. Meanwhile, the long call will be $20 out of the money with a year to go. Since you were bearish on IFF stock, you would likely sell the option before expiry and take a slight loss of $150 ($1,250 - $1,100).
Is It Wrong to Be Bearish?
The two-call option example I’ve provided takes a bearish viewpoint. With its stock up nearly 26% in 2024 and 47% over the past year, I’m clearly in the minority based on investor sentiment.
According to the Barchart Technical Opinion, IFF is rated a Strong Buy by 10 of the 19 analysts that cover its stock (3.95 out of 5) with a target price of $104.35, barely above where it’s currently trading.
It's been some time since I last covered International Flavors & Fragrances. I seem to remember that it had a significant amount of debt.
The Deal discussed its debt issues last December, noting that it doled out $26.2 billion in 2021 for DuPont’s (DD) nutrition and biosciences business. As a result, it was forced to embark on a divestiture plan to shrink its debt to 3.0x EBITDA from 4.5x at the end of 2022. It hoped to get there by 2024.
“With Carl Icahn peeking over its shoulder and a debt downgrade seemingly looming, IFF appears to be a highly motivated seller,” wrote The Deal’s Tom Terrarosa in December.
According to S&P Global Market Intelligence, IFF’s total debt to EBITDA at the end of June was 5.0x EBITDA, which is nowhere near its goal. It has cut about $2 billion of its debt after completing the DuPont acquisition, but it’s still more than double what it was before the purchase.
With revenues declining since the end of 2022, IFF is not the best stock for the long haul. Buyer beware.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
