Only individuals who are bullish on the long term prospects of McDonald's (MCD) should consider employing this strategy. If you are not bullish on this stock, then it would be in your interest to look for alternative plays.
Some reasons to be bullish on McDonald's Corp:
- A strong levered free cash flow of $3.8 billion
- A splendid history of increasing dividends consecutively for 35 years
- A three year and five-year total return of 63% and 99% respectively
- Annual EPS before NRI surged from $1.93 in 2009 to $5.27 in 2011.
- A good payout ratio of 52%
- Year over year projected growth rates of 7.87% and 10.8% for 2012 and 2014 3 respectively.
- Net income increased from $4.5 billion in 2009 to $5.5 billion in 2011.
- A five-year dividend growth rate of 20%
- Cash flow per share increased from $5.21 in 2009 to $6.76 in 2011.
- An excellent interest coverage ratio of 15.33
- A 5 year ROE average of 31%
- A projected 3-5 year EPS estimated growth rate of 9.9%
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It has fairly strong support in the 80-83 ranges and given the tendency of the markets to overshoot in both directions, there is a decent chance that it could test these ranges before a bottom is in place. With that in mind, the following strategy can be implemented. This strategy has two parts to it.
We would wait for it to test the 85 ranges and then sell the Jan 2014 82.50 puts. They are currently trading in the 9.50-9.60 ranges. If the stock pulls back to 85, these options should trade past $10. For this example, we will assume that we are able to sell these puts for 10.00 if and when it trades down to 85.00. For each contract sold $1000 will be deposited in your account. If you do not want to wait until it dips down to 85, you can sell the puts at the current price and deploy the proceeds in the second part of this strategy.
The Jan 2015 92.50 option is trading in the 5.70-5.95 ranges. A pullback to the 85 ranges should drive the price of this option down to 5.00 or lower. For this example, we will assume that we are able to purchase these calls for $5.00. Investors can now purchase one or two calls with the proceeds from the sale of the Jan 2014 82.50 puts. If you purchase 2, then you will have used up all your funds but your position will have more leverage, and you will have achieved this without any out of pocket cost. If you purchase one call, you will still have a decent amount of leverage, and you will also have an additional $500 sitting in your account. If the stock trades below 82.50 and the shares are assigned to you, then your final cost will be 77.50 (82.50-5.00).
For those who do not want to wait, you could sell the Jan 2014 82.50 puts and the current price and then purchase the Jan 2014 95 calls. In this way, you would still be able to purchase roughly two calls for every put sold.
The stock trades below the strike price, and the shares are assigned to your account. If you sold two calls then the strike price will be your final entry cost. If you sold only one option, your final cost could be as low as 77.50. If you are bullish on the stock, you will not mind owning the shares at this price. This is why we stated right from the onset that this strategy was only for individuals who have a bullish outlook on this stock.
For investors looking for other ideas detailed data has been provided for one additional company.
Company: Johnson & Johnson (JNJ)
Basic Key ratios
- Relative Strength 52 weeks = 59
- Dividend 5-year Growth = 7.95
- Cash Flow 5-year Average = 5.51
- Net Income ($mil) 12/2011 = 9672
- Net Income ($mil) 12/2010 = 13334
- Net Income ($mil) 12/2009 = 12266
- EBITDA ($mil) 12/2011 = 16090
- EBITDA ($mil) 12/2010 = 20341
- EBITDA ($mil) 12/2009 = 18980
- Cash Flow ($/share) 12/2011 = 6.23
- Cash Flow ($/share) 12/2010 = 5.91
- Cash Flow ($/share) 12/2009 = 5.68
- Sales ($mil) 12/2011 = 65030
- Sales ($mil) 12/2010 = 61587
- Sales ($mil) 12/2009 = 61897
- Annual EPS before NRI 12/2007 = 4.15
- Annual EPS before NRI 12/2008 = 4.55
- Annual EPS before NRI 12/2009 = 4.63
- Annual EPS before NRI 12/2010 = 4.76
- Annual EPS before NRI 12/2011 = 5
- Dividend Yield = 3.9
- Dividend Yield 5 Year Average = 3.16
- Dividend 5 year Growth = 8.23
- Payout Ratio = 0.45
- Payout Ratio 5 Year Average 12/2011 = 0.43
- Next 3-5 Year Estimate EPS Growth rate = 6.57
- 5 Year History EPS Growth 12/2011 = 4.38
- ROE 5 Year Average 12/2011 = 26.32
- Current Ratio 12/2011 = 2.69
- Current Ratio 5 Year Average = 1.94
- Quick Ratio = 2.11
- Cash Ratio = 1.64
- Interest Coverage Quarterly = 35.32
This strategy provides you with the opportunity to leverage your position for free and pocket up to $500, depending on the number of calls you purchase. The risk is that the shares trade below 82.50 and the stock is assigned to your account. If on the other hand the stock performs well you could end up banking some very handsome gains with no out of pocket expense. This is a great strategy to employ if you are bullish on the stock as the worst case scenario is you end up getting more shares at a lower cost.
EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Earnings and growth estimate data provided by dailyfinance.com. Option's table data and insider transactions sourced from yahoofinance.com.