I remember the days where we were interested in media-hyped battles over who’s a fan of The Coca-Cola Co (NYSE:KO) or PepsiCo, Inc. (NYSE:PEP). Today, soda companies are like tobacco businesses, as sugary drinks combat a rising tide of healthy alternatives.
While investors are busy with more timely hot topics like the cloud, Coca-Cola stock is not on the radar of many traders. Sometimes boring is beautifully consistent and therein lies my opportunity. I like to bet on value and in this case prices action.
Fundamentally, KO stock is not cheap. It trades at a 42 price-earnings ratio. Compare that to say Apple Inc. (NASDAQ:AAPL), which has a P/E under 17 and it becomes obvious that there is room for downside but only if in the stock market flips to bearish bias.
For the mid-term, I remain cautiously bullish. In addition to the basic fundamentals of stock, we have corporations investing hundreds of billions of Dollars back into the US economy. This is in the form of capital expenditures, dividends, wage raises and bonuses. So I am confident that this will place a bid under the equity market in general.
Coming into the earnings, KO stock was slightly down year-to-date but the one-year performance is up over 10%. This earnings spike will add to the momentum. I can buy the upside potential for the long run. But in this fragile sentiment-trading environment I’d rather sell downside risk against the recent levels of the flash correction to generate income from KO stock.
Click to EnlargeTechnically, the recent dip that The Coca-Cola Co took with the market-wide correction gave us a floor against that I can rely on as interim support.
The selloff was violent, but it showed the worst-case scenario in the stock under current macro and micro fundamentals.
The experts agree with me since KO is still trading well below their average price targets. Most analysts have a “hold” rating on it, so the chances of surprise downgrades are minimal. Management is proven over decades and will continue to find ways to adapt to the changes in consumer tastes.
The Trade: Sell KO June $41 naked put and collect 60 cents to open. Here I have a 85% theoretical chance that I would retain maximum gains. But if price falls below my strike then I own the shares and would suffer losses below $40.40.
Selling naked puts is daunting especially near all-time high stock markets. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell KO June $41/$39 credit put spread. The spread has the same odds but would deliver 15% yield on risk. Neither trade requires a rally to profit. In fact, the stock can have another correction and I could still retain maximum gains.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free 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.