Misses for profit and revenue at Coca-Cola (KO) on Tuesday, coupled with signs of slowing demand for its beverages in traditionally resilient emerging markets, saw its shares slide towards 52-week lows ($36.83 on 10/07/2013). The opportunity to reach for the stock at bargain levels was too tempting for some option traders according to activity centered on options expiring Friday as they bought bull put spreads on the Warren Buffett favorite. Shares in Coca-Cola closed the day at $37.47 (down by 2.9%) and while that is 37-cents above its February low (+1.00%), that rebound is slim in comparison to that of the broader S&P 500 index, which is up by 5.75%.
Chart – Coca-Cola nears October low
(click to enlarge)
According to our option scanners, one of the favored combinations using Friday’s expiring options amongst traders was to sell February 21 ‘14 expiry put options at the 37.5 strike and buy the lower 37.0 put in the event of worsening declines for Coca-Cola’s share price. As the sold upper strike is more expensive, the investor created a credit spread worth around 20-cents. Should the stock settle at or above the higher strike price on Friday, the option trader keeps the full premium. Should shares settle below $37.50 the trader still keeps the premium but will have shares put to him at the strike price. In effect the investor is getting the shares at a 20-cent discount when the net option premium is considered. At the lower strike the investor is also able to put the shares to the put seller and so faces limited losses of the distance between the strikes less the 20-cent premium (0.50 – 0.20 = 0.30-cents)
As the day wore on the trade started to look pretty attractive given the resilient performance of the share price closing at $37.60. Of course it is not Friday yet and shares in the company are slightly weaker at $37.44 at Wednesday’s opening.
While the option combination was a response to an earnings shock, the strategy may yet work out well for the investor. We can only assume that the risky strategy of taking delivery of the stock close to its 52-week low is an appealing proposition, while at the same time they have limited near-term losses. The fact that the broad market is looking somewhat wobbly could even be perceived as a positive factor for Coca-Cola as a consumer staples company. Meanwhile, a pair of Coca-Cola downgrades from Wall Street analysts does not seem to be weighing on the company in early trading. Analysts at Bernstein lowered the price target for the stock by $3.00 to $43.00 while Credit Suisse cut its target from $48.00 to $46.00. Both targets remain well above Coca-Cola’s prevailing price. This will be an interesting battle to watch heading into Friday’s expiration.