A sizzling earnings reaction in Chipotle Mexican Grill, Inc. (NYSE:CMG) has more than a few investors now anxiously placing buy orders for CMG stock. But for this strategist, it’s business as usual — using Chipotle’s options menu and a bull call spread to begin nibbling. Let me explain.
It’s time for a big ol’ sombrero hat tip for a pre-earnings bullish vertical on CMG stock discussed last week at InvestorPlace. The strategy is set to capture $9.40 Friday or 300% with the short-term and now well-in-the-money spread exploding in value from $3.10 to $12.50 per contract. Ole!!
Behind Thursday’s rather dramatic 24% price spike in Chipotle shares, the fresh-fast restaurant chain posted mixed, but promising, results which topped views. More importantly, there’s proof in the guacamole the newly appointed CEO is transitioning the company for a successful turnaround following a couple years of health and earnings scares which left a bad taste in the mouths of investors.
CMG Stock Monthly Chart
Thursday’s 24% price spike in Chipotle shares was certainly a surprise to this strategist. I previously made the case for an upside breakout, but potential resistance around $365 in CMG was seen as a legitimate reason for reducing long exposure with our outlined short-term vertical spread.
Looking ahead, with CMG stock aggressively higher and well above the discussed inverse triangle resistance, I’m a fan of buying the name on weakness. But will a clearly overbought short-term situation allow for that type of entry?
Possibly not, if bullish investors only focus on shares. There is always the chance Chipotle continues to move higher before eventually consolidating. So what’s a bull supposed to do?
The Chipotle Stock Bullish Strategy
For like-minded bullish traders wanting to position on a pullback, but realizing shares of Chipotle could simply continue to run higher and never afford an entry that looks like our ideal buy point, a legged modified fence may be the answer.
The idea for this trade is to buy an out-of-the-money bull call spread in case shares continue to run higher. At the moment, the June $440/$460 call spread for less than $7 is one vertical that allows some time on the calendar for the spread to go in-the-money without requiring too much upside from CMG stock.
If after purchasing the call spread, profit-taking in Chipotle shares does occur, the trader would look to sell a put vertical spread to help finance part, all or even allow a net credit for the entire modified fence position consisting of the two bullish verticals.
Following the put spread sale, the real payoff would be for Chipotle shares to reverse and begin to trade to new highs. This trader ultimately wants the call spread to go fully in-the-money in order to receive the max payout of $20 minus any potential cost for entering the combined position.
Alas, if Chipotle continues to trade even lower, the trader has sold a put spread, so there is downside exposure. Bottom line though, if you’re like me and do view buying on weakness as an opportunity rather than a reason to panic and take a loss — this limited and defined risk strategy offers the best of both worlds to bullish traders without the heartburn.
Investment accounts under Christopher Tyler’s management currently own positions in Chipotle stock (CMG) and/or its derivatives. The information offered is based upon Christopher Tyler’s 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 and StockTwits.
