The Striking Price

McDonald's: How to Play It With Options

STEVEN M. SEARS

Saturday, September 13, 2014

Investors who own the shares at a lower-cost basis can pay themselves while waiting for better days to arrive.

In one of the year's great examples of Wall Street poetics, Janney Capital Markets' Mark Kalinowski headlined a research note, "That's not ketchup…it's blood," after another bad McDonald's sales report.

McDonald's (ticker: MCD) same-store sales fell in August 2.8%, which may not seem much, but investors anticipated a mere 2% decline. The shortcoming was another reminder that McDonald's is struggling to find its niche in an increasingly health-conscious America.

With a menu famous for cholesterol, sodium, and the occasional dollop of trans-fats, McDonald's stock is now about as beloved as arterial plaque and obesity. The stock is largely unchanged this year, and investors are worried McDonald's is having a hard time reinventing itself.

Fast-food poet manqué Kalinowski admits that the stock isn't likely to fall much more after dropping below $100 not long ago. But it's also unlikely the stock will advance without near-term catalysts.

This lack of anticipated movement makes McDonald's shares, one of the U.S.'s most widely held stocks, an ideal candidate to sell options against. Because the stock is likely to trade in a tight range, investors who own shares at a lower-cost basis can pay themselves while waiting for better days to arrive. Chris Jacobson, Susquehanna Financial Group's derivatives strategist, is telling clients to sell a "covered strangle" against the stock. He likes selling the January $87.50 put and $97.50 call.

If the stock stays within the $87.50 and $97.50 range, strangle sellers keep the $2.36 premium received for executing the trade. If the stock dips below $87.50, investors are obligated to buy stock or cover the put at a higher price. Similarly, if the stock rises above $97.50, investors must sell their stock or cover the call.

AT A TIME WHEN THE U.S. options market is split between so many exchanges that it's hard to keep count, there's talk that two more exchanges are launching. If this happens, 14 markets would divide a sclerotic liquidity pool that is struggling to support a lean options industry.

Details are scarce, but this much is certain: The options market has too many exchanges. Major investors regularly complain that the fragmentation of liquidity, especially for stocks, is driving up execution costs.

Few investors complain about paying a premium for a quality execution. But paying a premium because exchanges are slicing up liquidity is not right.

At this point, the somnolent Securities and Exchange Commission, which always seems focused on yesterday's issues, needs to apply a public-service test to new exchange applicants—and some old ones. If a planned exchange primarily appeals to a certain trading style or technology, the SEC should hesitate to approve it.

Exchanges should be required to demonstrate that they meet some public good or market betterment. Something is amiss when exchanges exist not to raise capital or serve the public, but to facilitate trading methods that are hard to explain to most educated people.

All brokers and dealers must execute orders at the National Best Bid and Offer. But there's a risk that some exchanges, current and planned, misuse NBBO to benefit themselves, by collecting tape fees and trading taxes everyone has to pay to monitor prices. Many investors admit NBBO is a meaningless ideal, diluted by payment for order flow and internationalization.

The SEC, which in its better days claimed to be the investor's advocate, needs to advocate once more. Something is wrong when exchanges largely exist on the strength of regulatory, tape, and technology fees collected simply for turning on the lights each day.

Reprinted by permission of Barron's Online, © 2014 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

The views expressed in the above papers and articles are solely those of the author of the article, and do not necessarily reflect the views of OIC; the information presented is not intended to constitute investment advice or recommendations to purchase or sell securities of any company; and the information presented is based upon particular events that may or may not recur in the future.

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