Chipotle (NYSE:CMG) is no stranger to harsh headlines. We all remember the 2015 news of food-related sicknesses that brought CMG stock to its knees. Gone were the long lines in the stores and so were the days of $700-per-share.
Under new leadership, it made a comeback. The stock finally found support in February in a double-bottom after two favorable earnings reports. Wall Street was falling back in love with CMG stock.
Until last night when a headline of a store closure in OH broke out. CMG fell 5% in after-hours trading on the news.
Technically speaking, this dip is not surprising as it coincides with a long-term pivot point. Those can be resistance on the way up because both bulls and bears would want to fight them out again in the same spots. Headline or not, Chipotle stock was due to encounter resistance above $480-per-share regardless.
Luckily for bulls, CMG stock was up 50% year-to-date and 35% in 12 months. So there are fast profits and those tend to be weak hands. Luckily, the analysts on Wall Street are still realistic with their expectations. Most have it as a hold, so a slew of downgrades are not likely.
Fundamentally speaking, the stock is not cheap. It still sells at a price-to-earnings ratio of 80 and for a restaurant, this is very high. It is four times that of McDonald’s (NYSE:MCD) stock, which sells at a P/E of 20.
So catching the falling knife here is not an obvious opportunity. However in the midterm, I believe that fans of the stock will defend it as long as the headlines abate. And therein lies the opportunity. Today’s trade aims to generate income from what others fear.
I want to bet on downside support to hold through 2018, but with shorter-term caution. For the next few weeks, CMG stock is vulnerable to more downside, so the setup will be a pair trade to guard against this possibility.
Investors in this case may have been once bitten and twice shy. In other words, this time traders will likely want to see concrete reports as to what actually happened before they feel comfortable owning the stock.
Going long the stock now is not an endorsement of its value. This is a pure play on its stock price action off an inflammatory headline. Already overnight CMG bulls defended the stock, which is encouraging for those who hold it.
Eventually if the news dies out, then this too will be forgotten. After all, it has been mere days when management delivered great earnings, so it’s too early to discount it all back right away.
Two Ways to Trade CMG Stock Today
The Bullish Bet: Sell the CMG Jan 2019 $320 put. This is a bullish trade for which I collect $4.50 to open.There’s an 85% certainty that I will retain maximum gains with this trade. But if the price falls below my strike, then I own shares. I would then need to manage off my breakeven point of $315.50. Selling naked puts carries big risk, especially for a stock as frothy as CMG. For those who want to mitigate it, they can sell a spread instead.
The Hedge (optional): Buy the CMG Aug 24th $430/427.50 debit put spread, where there is an opportunity to quadruple your money if the price falls through the spread by late August.
The net effect of this pair is a credit, so any premium I recapture from selling the August spread would be pure profit.
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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.
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