Daily Stock Market Equity and Options Trading Commentary

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Monday, April 27, 2009

Blazin' HOT Option Strategy

Today I will post about an option strategy that has made me money every time I've used it. It involves a small cap stock and an options straddle. First of all I'd like to start by giving a background of a small cap company known as Buffalo Wild Wings. It is a restaurant with a nice atmosphere and known for their delicious wings-hence the name. They they have 14 different sauces for their wings- the hottest being Blazin' (if you're daring, you should try them sometime... HOT!). In the past 2 years they have gained a lot of popularity by having Mixed Martial Arts (MMA), notably Ultimate Fighting Championship (UFC) pay-per views. As you may know MMA has become extremely popular in the past 5 years and Buffalo Wild Wings has these featured "fight nights" and are able to attract a HUGE crowd. Personally I think Buffalo Wild Wings (BWLD) will blow away the quarter, but I certainly don't want to be too sure in this market/economy. Therefore I'm playing on both sides of the fence, or in the options world we call this fence the strike price. Historically when BWLD misses the quarter they get beaten down (20%+), and if they beat the quarter they seem to have a massive gain (20%+). First I'd like to state 5 reasons why I think BWLD is a great company and even investment worthy. Then I'll tell you about the strategy I implement before they report earnings every quarter.

First of all BWLD has a very good product, it is a cool and clean atmosphere (they have like 60 TV's tuning into sports from all around the world on all the time), not to mention they have a well designed interactive website. Second, like every restaurant chain, they have massive margins, however they make most of their money on the sales of alcohol (which as you may know are even bigger margins). Third, the price of chicken was down in Q1 from the previous quarter and their major food items are all chicken products, this means margins on these items are even greater than the previous quarter. Fourth, these guys are growing at a phenomenal rate and will continue to grow rapidly, they are expected to grow earnings by 24% in 2009, and another 23% in 2010. And fifth, quarter 1 includes one of the busiest days for Buffalo Wild Wings... Super Bowl Sunday. It is like the black Friday for retail stores, and each BWLD location had a super bowl party.

Now that I have given you 5 reasons to invest in BWLD here is one reason why I speculate with them and capture either the upside or downside. BWLD being so volatile after earnings makes it an ideal candidate for purchasing an option straddle on. BWLD closed today at 42.10 so this makes it hard without there being a strike for 42.50 (at times like this I'd look at playing the 40 put and 45 call which is a bit cheaper, but even more dangerous). However the price as of today's close is closer to the 40 strike therefore I'd most likely be buying both PUTS and CALLS on the 40 strike. Best case scenario would be for BWLD to trump earnings and for the overall market to be having a good day. BWLD has a 32% short interest, so if they have a real good quarter and give good guidance, we could see a huge short squeeze. As I said BWLD usually moves at least 20% one way or the other which gives us $8.42 up/down. Last time they reported good earnings it moved up 34% in a single day, followed by about 3% additional in the following 5 trading days. A straddle for BWLD will cost about $700 with 18 days left until expiration, but if we can get a good move up or down from BWLD, I think breaking even at worst won't be a problem. The key is to flip the straddle while it still has a decent time value- I usually flip it the next day. Historically shorts have about 12 days to cover, this implies we could see a nice rally for 12 days before it pulls back, however I usually don't get greedy and I take my profits immediately. The worst case scenario is if BWLD meets expectations and does not move that much in one way or the other. This is something you need to be careful of especially if debating to purchase a spread like the 40 PUT contract and 45 CALL contract. Ideally I would like to purchase the straddle while the stock is closest to 40 or 45 and would look at doing a spread if it was near 42.50. Good luck!

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