Domino’s Pizza, Inc. (NYSE:DPZ) reported earnings last week and it sold off hard. Historically, high-profile investment experts have loved DPZ stock and they usually defended it on dips. So investors are likely to buy this dip too and therein lies the opportunity I want to capture today.
Although I believe history will repeat itself here, Domino’s Pizza has been a violent stock. It moves fast and long in one direction or the other, so I have to be cautious with my entry points.
To minimize the risk of bad timing, I will use options instead of buying DPZ stock outright and hope for a bounce. There, I can build a buffer to account for the fact that I may not catch the perfect bottom.
Even though Domino’s Pizza stock is reasonably priced compared to its competitors, it’s still not a screaming bargain in absolute terms. The whole sector is aggressively priced. Just for absolute comparisons, Apple Inc.’s (NASDAQ:AAPL) price-to-earnings ratio is one-third cheaper than most of them, so there is more room to fall before DPZ becomes oversold.
Technically, this is not an obvious bullish entry spot from a weekly chart. But the daily shows that more favorable entry levels are here. $185 per share has been a zone of contention and these usually lend support to falling stocks. Both bulls and bears will want to win, so they fight hard for it and the area becomes temporarily sticky. Domino’s Pizza stock pays a dividend, so that should lend some support in tough times.
Expectations on Wall Street suggest that there could be more upside room than down. DPZ is now trading below the average price target. Most analysts have a HOLD rating on it. There is no obvious imminent threat to their consensus at this time.
It’s important to note that there is risk as its competitors report earnings. For example Del Taco Restaurants Inc (NASDAQ:TACO) reports earnings this week and that will likely cause a move in Domino’s Pizza stock.
But, since I am taking a longer-term trade, I won’t worry too much about the short-term influence from sympathy moves. With a 20% pad, I am confident that I will be able to manage my risk successfully if my thesis fails.
Bottom Line on DPZ Stock
The Trade: Sell the DPZ Mar 2018 $150 naked put. This is a bullish trade for which I collect $2 to open. Here, I have an 85% theoretical chance of success. But if the price falls below my strike, then I must own the shares. I could accrue losses below $148.
Selling naked puts carries sizable risk, especially for a three-digit stock price tag. But I can mitigate it if I sell a spread instead.
The Alternate Trade: Sell the Mar 2018 DPZ $155/$150 bull put spread. Here, I have similar odds of winning. The spread would deliver 10% in yield on risk, but I don’t need a rally to profit in either case. In fact DPZ stock can fall another 20% and I still win.
Compare this with risking $193 to buy the shares at face value here and without any room for error, expecting a rally to profit.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never 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 as @racernic on twitter and stocktwits.