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Demand for Delivery Could Provide a 30% Gain

Demand for Delivery Could Provide a 30% Gain

Trade summary: A bull call spread in Papa John’s International, Inc. (Nasdaq: PZZA) using the October $90 call option which can be bought for about $4.90 and the October $95 call could be sold for about $2.73. This trade would cost $2.17 to open, or $217 since each contract covers 100 shares of stock.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $217. The maximum gain is $283 per contract. That is a potential gain of about 30% based on the amount risked in the trade.

Now, let’s look at the details.

PZZA has been seeing a large increase in demand for its product since lockdowns began. Management also understands that investors face a great deal of uncertainty in the current environment and are taking steps to provide additional information to investors.

As part that effort, the company recently provided preliminary estimated comparable sales information for the August fiscal period. In light of the uncertainty and volatility related to the pandemic, the company has continued to provide this information on a monthly basis.

President & CEO Rob Lynch said, “Papa John’s sales, driven by product innovation, remained strong in August. As we have added new customers throughout 2020, our customer satisfaction and brand affinity scores also continue rising. Our international business gained further momentum in August too and continues to improve as more countries across the globe open back up for business.”

From July 27 through August 23, North American systemwide comparable sales rose 24.2%. This growth was from increased delivery and carry out sales during the pandemic.

Much of the growth came at stores owned by franchisees which reported increased sales of 26.1%. Company owned locations reported growth of 18%.

International restaurants saw 23.3% growth in same-store sales.

The company also reported on closures and here the news was positive, “Of the company’s approximately 2,100 international franchised stores, the number temporarily closed has declined to approximately 150, primarily in Latin America and Europe, in accordance with government policies.

In North America, almost all traditional restaurants remain open and fully operational. A number of non-traditional restaurants located in universities and stadiums are temporarily closed; these non-traditional locations are not material to the company’s revenues and operating results.”

According to The Street, “In May, the company reported a record 33.5% jump in comps as Americans sheltered in place and ordered out in the early stages of the coronavirus pandemic.

May was the second straight month for which the pizza maker reported the best sales period in its history.

“We entered the pandemic with strong growth and momentum and are fortunate that our delivery and carry-out model has enabled us to meet an essential need for high-quality food, safely delivered to consumers’ homes,” Lynch said in a statement in May.

In July, the company said it intended to hire 10,000 additional workers over the following few months after boosting its workforce by 20,000 during the coronavirus pandemic.

Papa John’s is one of many food retailers that have added jobs during the coronavirus pandemic as homebound consumers turned to ordering and delivery.”

The stock has been consolidating recent gains.

PZZA daily chart

The longer-term chart shows the stock is at multiyear highs, a bullish indicator as long as risk is considered.

PZZA weekly chart

A Specific Trade for PZZA

 For PZZA, the October options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.

An October $90 call option can be bought for about $4.90 and the October $95 call could be sold for about $2.73. This trade would cost $2.17 to open, or $217 since each contract covers 100 shares of stock.

The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $217.

The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

For this trade in PZZA, the maximum gain is $283 ($95- $90= $5; 5- $2.17 = $2.83). This represents $283 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $217 to open this trade.

That is a potential gain of about 30% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

A Trade for Short Term Bulls

As with the ownership of any stock, buying PZZA could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will be relatively small to own an option.

To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

Source: The Options Industry Council

Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.