Despite an earnings beat and positive outlook, investors were behaving like crazy bears in El Pollo LoCo Holdings Inc (NASDAQ:LOCO) for a second session Monday. But looking at the other menu options available in LOCO and the grilled bull being served looks tempting to sample using a well-placed and well-priced credit put spread.
There’s an expression the market is always right. And it is, until it isn’t. That type about-face of course happens often enough as to not order what the other guy is devouring.
And that’s my interpretation of El Polo Loco shares after Monday’s bearish follow-through and why ordering a well-priced and bullish put spread is an appetizing, contrarian position to order right now.
The angst behind El Pollo Loco stock’s two-day, 17% sell-off appears to have the excuse of weak same store sales comps and a slight reduction to its full-year earnings and a range of 67 to 71 cents compared to analyst forecasts of 71 cents.
On the other hand and taking a definitive backseat with El Pollo Loco investors, earnings of 18 cents did top forecasts by a penny. Similarly, revenue growth of 17% on sales of $90.4 million topped Street views of $88 million.
Additionally and not being paid any respect, Barron’s noted on Friday a couple Baird analysts were still optimistic on El Pollo Loco. They expect the company to still deliver EPS guidance of 21% to 28% this year and see the sell-off as offering “a good entry point for patient investors.”
El Pollo Loco Daily Chart
Referencing the El Pollo Loco daily chart and its apparent investors aren’t exactly satisfied with their prior order in LOCO stock. But, given an overall decent report and quite likely an overreaction due to expectations being set too high; the same LOCO stock chart is offering a very nice entry area technically after two days of pressure.
At last check, shares of El Pollo Loco are just piercing the 38% Fibonacci level while filling in a prior bullish gap. I’m sure the news back then was equally compelling! Monday’s test of what I’ll refer to as initial support, is interesting, particularly as LOCO finds itself outside its lower Bollinger Band for a second consecutive day.
The question would-be bulls in El Pollo Loco stock are most interested in is whether investors are finished gutting LOCO stock of its apparent fatty layer? If the crowd does proceed with its bearish preoccupation, the prior low of $23.34 and highlighted in yellow, is where I’d estimate selling pressure dries up—or otherwise face challenging its 2014 end of year low of $19.85.
The importance behind $23.34 as a second support area is how it lines up with the 62% retracement level, as well as being a weekly chart, candlestick pivot low within the still-existing, but fragile uptrend in El Pollo Loco stock.
As approached, a closing breach of this second support in El Pollo Loco shares is not something I’d want to be involved with as bull, and all bets would be off the table until a full retest of $19.85.
El Pollo Loco Bull Put Spread Strategy
In drawing up today’s bullish narrative for El Pollo Loco stock but not being a glutton for punishment, limited risk verticals are a suitable way to participate. At the end of the day, the trader knows exactly how much they stand to profit or lose. One in particular which looks appetizing is the Jun $23/$22 bull put spread, priced for 30 cents mid-market.
Looking at the El Pollo Loco volatility chart and the pricing of premiums relative to the underlying stock movement could be viewed as inexpensive enough to consider buying a call if a trader were bullishly inclined. However, we see the June vertical as the better menu option though.
Aside from limiting a trader’s maximum risk and similar in that respect to a purchased option contract, the El Pollo Loco June bull put vertical is able to remove most of the volatility risk.
The LOCO put spread also trades for a nice size credit relative to its maximum risk of 70 cents with 33 days to expiration. And remember the full credit of 30 cents remains intact above $23 in El Pollo Loco stock, which is still a full 5% above the sold strike price.
And should crazy El Pollo Loco investors find themselves pressuring LOCO stock slightly below the March pivot low, before reversing higher (optimistically), the protection and still profitable wiggle room afforded by the June put spread would come in handy.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon his observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
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