Chipotle Mexican Grill, Inc. (NYSE:CMG) cannot get out of its rut of bad headlines. It took years to start making the turn out of the last devastating health scare and in came a new one: More headlines of people sick from eating at Chipotle restaurants.
While management identified the issue and addressed its resolution, this one came with a twist: a viral video of rats falling from one of its restaurant’s ceiling. It’s almost as if someone is trying to keep kicking this horse when it’s down.
The end result of this new wave of bad news was a swift 15% correction.
Technically, I can explain the dip because the threat loomed since $410. But the added headline-risk could make this scare last longer. I don’t expect a spring-board action, but all I need for this CMG trade is some stability.
The trick for me is to find a solid support level against where I can sell premiums for income. But in this case, there are no assurances that they will hold. They could act as temporary support, however, and that’s all I need for my trade.
Today I want to sell some puts for income against what I believe will hold through the next few weeks. This will be a trade which I don’t intend on turning into an investment. Because even after a big fall, the stock is bloated versus its peers.
CMG stock is still is priced as if it were a star restaurant chain turning incredible comp sales. It’s not. That honor now belongs to McDonald’s Corporation (NYSE:MCD), at least in Wall Street’s view. Investors are fickle, and these days they see gold in the golden arches not in burrito bowls.
What really hurt Chipotle stock is that these headlines came at about the same time management warned they were running higher operating costs than expected. Considering the confluence of bad news, I am surprised Chipotle isn’t trading lower.
At some point, Steve Ells & Co. have to admit that the old comps are not coming back and that they should make due with what they have now.
Since CMG stock is still expensive from a price-earnings perspective, I am not going long its value. I am betting (and yes, it’s a gamble) that it will soon find footing and before it hits my risk.
Otherwise, I must own the shares at that price, then manage out of it quickly to avoid serious damage. I don’t intend to be a long-term investor.
The Bet: Sell the CMG Dec $260 put for $3.25 where I have a 90% theoretical odds of winning. But if price falls below my strike, I could accrue losses below $256.75.
Selling puts in a three-digit stock requires margin, but I can mitigate this risk by selling spreads instead. In addition to selling the puts, I buy an equal number of puts lower, thereby limiting the maximum loss potential.
The Alternate: Sell CMG Dec $260/$270 credit put spread, where I have about the same chance of winning but with fewer dollars at risk. If I succeed the spread will delivery 15% in yield.
I only need price to stay above $260 to win in either of these trades. So Chipotle stock could fall an additional 25% and I could still win this bet.
But selling options is risky business, even with a buffer this size. That said, I won’t risk more than I’m willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
