For the past five weeks, PepsiCo, Inc. (NYSE:PEP) stock is down 5% while the stock market has been setting new high after another. More worrisome is the fact that the last 10 days, the price fall has been precipitous and with no signs of stabilization. Normally I don’t like to catch the proverbial falling knives, but today I want to share a bullish trade on Pepsi — one that doesn’t rely on upside prices in order to profit.
The concept is simple. I find support levels that will hold up through 2017 and I sell risk against them for profit. These option trades require no money out of pocket — in fact money goes into my account for opening them. The only caveat is that I commit myself to buying the shares at the levels I choose if prices go there.
This is not the same as calling the bottom then buying the shares and needing a rally in order to profit. I can still profit even if Pepsi stock falls another 12%.
At $111 per share, PEP stock is at a pivot point. This is a level that the bulls breached in March of this year after failing just over a year ago. Here they are, back at it again but this time from the top. So I think the bulls and bears will square off over this area once more. Neither side will be willing to let it go without a fight.
This should translate into some sort of support. But I’m not going to even count on that alone for my trade. I’m going to go even lower for extra caution.
Fundamentally speaking, PEP is much cheaper than The Coca-Cola Co (NYSE:KO). Its price-to-earnings and price-to-sales ratios are about half of that of KO.
Click to Enlarge So from a valuation perspective, I’m confident that there is value in the stock already. Most of the froth is already out, and therein lies the opportunity.
Analysts agree because Pepsi stock is now trading below all Wall Street price targets. The average price target is currently about 12% higher than here. So they see upside in it. Furthermore most of them rate the stock as a buy or a hold. This reduces the chances of having a downside surprise headline.
PEP Stock Trade Idea
The Bet: Sell the PEP Jan 2018 $95 put for 50 cents. Here I have a 90% chance that I will retain maximum gains. But if price falls below my strike I accrue losses below $94.50.
Not all traders like selling naked puts and those can sell spreads instead to mitigate the risk.
The Alternate Bet: Sell PEP Jan 2018 $100/$97.50 bull but spread which is also a bullish trade but with less dollars risk. Yet if successful it will yield 12% on risk. The buffer on the spread is slightly smaller than the naked put but that’s the trade off: less dollars at risk but a lower chance of success.
It is important to note that in either of the setups I’d only a rally the profit. Compare that with needing to risk $111 per PEP share then hope for a 12% rally just to match the performance of the spread.
Investing is risky so I never bet more than I can afford 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 as @racernic on twitter and stocktwits.
