McDonald's Corp (MCD) stock has been flat for the past 3 weeks since its earnings were released. This is ideal for investors who short out-of-the-money (OTM) put options to gain extra income.
MCD is at $295.24 in midday trading on Tuesday, Nov. 26, roughly the same as its closing price on Oct. 29 ($295.00) when its Q3 results came out. However, it's well off a recent high of $316.86 on Oct. 18.
Moreover, MCD could be worth substantially more, as its free cash flow (FCF) supports a higher price. Analysts also have much higher price targets.
As a result, value investors are paying attention, especially since McDonald's recently hiked its dividend. They are looking to buy MCD stock cheaply at lower prices by shorting out-of-the-money (OTM) put options in nearby expiry periods.
I discussed this play in my Nov. 3 Barchart article, “McDonald's Hikes Its Dividend 6% - MCD Stock's 2.40% Yield Attracts Value Buyers.”
Price Targets
Analysts surveyed by Yahoo! Finance have an average price target of $321.51, and Barchart's mean survey result is $323.55, or +9.6% higher than today. Moreover, AnaChart.com, a new site that tracks sell-side analysts' price recommendations, shows that 29 analysts have an average target of $332.30.
That price target is higher than 3 weeks ago when I reported it was at $331.32. In other words, analysts have been raising their price targets.
That is not surprising given that the company raised its annual dividend per share (DPS) to $7.08. That gives MCD a dividend yield of 2.40% (i.e., $7.08/$295.24).
This is still lower than its 4-year historical average of 2.20%, according to Seeking Alpha. That implies MCD is worth $321.82 per share, or+9.0% higher:
$7.08 / 0.022 = $321.82 ; $321.82 / $295.26 = 1.09 -1 = +9.0%
The bottom line is that MCD still has room to rise. One way to play this in the near term is to short OTM put options. That way the investor can set a lower buy-in target price and get paid while waiting.
Shorting OTM Puts for Income
In my prior article, I discussed shorting $280 and $285.00 strike price puts expiring this Friday, Nov. 29. The short-put yield was 0.507% and 0.74% at the time.
Today, those puts are almost worthless (trading for 2 cents to 4 cents), so that trade worked out. It makes sense to roll these over (i.e., buy to cover them) and short a new set of further away put options.
For example, look at the Dec. 20 expiry period, 24 days from now, or almost three weeks away. The $290 strike price, which is a little less than 2% below today's trading price, trade for $2.71 on the bid side.
That works out to a 3-week short-put yield of almost 1.0% (i.e., $2.71/$290.00 = 0.934%).
That is probably worth doing since the delta ratio is only -0.32, which implies a low chance that the stock will fall to this strike price.
Downside Risk Issues
Even if the stock falls to $290, the investor who shorts these puts actually has a lower breakeven:
$290 - $2.71 = $287.29 breakeven price
$287.29 / $295.95 trading price -1 = -.0293 = 2.93% downside protection
The point is that the investor has a breakeven price that is 2.93% lower than today, after including the short put income. That gives the investor a good buy-in price should the MCD price fall.
Moreover, even if that occurs the investor can short covered calls and/or more OTM cash-secured puts. That way they can gain extra income to help defray any unrealized capital loss.
The bottom line is that shorting OTM puts in MCD stock looks like a good play for value investors.
