by Jim Pearce, http://www.investingdaily.com/
Investing Daily Article of the Week
Okay, I admit it: I eat at McDonald’s (NYSE: MCD) about once a week. And I like it.
I know fast food isn’t good for me, but I need a quarter-pounder “fix” every once in a while. I also think McDonald’s stock is worth a bite at its current price, using a technique I’ll get to in a moment.
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Since McDonald’s has been testing self-ordering kiosks and table delivery at the location near my office, I was already aware of the big changes coming that were announced by the company’s CEO earlier this week. McDonald’s will be adding those services to 1,000 stores each quarter for the next two years.
It’s easy to understand why, since everybody wins:
- For customers, it means shorter wait times and less confusion at the cash register;
- For the store, it equates to faster turnover and more revenue per store;
- For shareholders, it should result in higher earnings and more money available for dividends and share repurchases.
The timing is right, too. Before the stock market tanked four months ago, McDonald’s was on a tear. From its low in October 2016 to its high in January 2018, its share price jumped 61% compared to a 34% gain in the benchmark SPDR S&P 500 ETF (SPY).
Since then MCD has hit the skids, surrendering 10% of its value. That doesn’t necessarily mean that it has become oversold and is now a screaming buy. Even after the recent setback, MCD is valued at 19 times forward earnings, higher than the market average.
However, MCD’s reduced priced combined with its improved long-term profit outlook makes McDonald’s a tastier investment than it was at the start of the year. But rather than simply buying the stock, there are two strategies you can use that work regardless of the stock’s movement.
Call Ahead Order
If you already own McDonald’s, you may be kicking yourself for not selling it back in January when it peaked near $178. But since you can’t go back in time, the next best thing may be to agree to sell it to someone else when it gets back to that price.
However, because nobody knows how long that may take, you may be sitting in the stock for a long time. In that case, selling a “covered call” option is one way to generate immediate cash flow regardless of how fast, or slow, it takes MCD to recover.
For example, a few days ago when MCD was trading near $159 you could have entered into an options contract to sell it for $175 that expires in three months, and receive a premium of $1 per share right now. If MCD never trades up to that price then the premium is yours to keep, and you still own the stock. Coincidentally, McDonald’s pays a quarterly dividend of $1.01 so in this case, you can think of the covered call premium as effectively doubling the dividend yield.
If MCD does trade above that price and the contract is exercised, you get paid $175 per share plus the additional dollar of option premium for a gross sales price of $176. That’s very close to its all-time high price, and you now have that money to use to buy another stock that is undervalued and ready to run up the charts like McDonald’s did.
Put Some Mustard On It
On the other hand, let’s say you don’t yet own McDonald’s but would like to if the price drops a bit more. In that case, you can sell a put option at a strike price below its current market value and receive a premium right away for doing so.
If MCD does trade down and the stock is put to you at the strike price, you become the proud owner of McDonald’s stock at a cheaper price than it is trading for today. For example, a few days ago you could have received $2 per share by selling a put option on MCD with a strike price of $150 that expires in September.
If MCD never trades down to that price by the time the option expires, the premium is yours to keep with no further obligation. If MCD does trade below that price and the put option is exercised, your cost would be the $150 strike price minus the $2 option premium for a net price of $148.
I would gladly buy MCD at a share price of $148, and I would be equally happy to sell it at $175. If this approach appeals to you, please take a few minutes to hear what my colleague Jim Fink has to say about his success at trading options.
