Some Sales Can Hurt a Stock’s Price
Thanksgiving kicks off the most important part of the year for retailers.
They offer Black Friday sales, Cyber Monday discounts and markdowns throughout the month of December. Some analysts believe retail markdowns are driven by sales data.
If sales are strong, retailers might have less need to lower prices. When sales are weak, lower prices are used to drive customer traffic. That is the primary reason behind Black Friday sales and why analysts watch data on sales for that day.
In recent years, traditional retailers have come under increasing pressure from several sources, most of all from online retailers. Their response has been to increase the number of sales they offer. Now, Black Friday begins on Thursday, the evening of Thanksgiving.
Online retailers have also responded to pressure to increase sales by offering discounts on what has become known as Cyber Monday. But, some retailers can create concerns for analysts by offering discounts that seem to be a little too generous.
Half Price Pizza for the Next Week
Domino’s Pizza (NYSE: DPZ)
DPZ is offering consumers an incredible deal. The company has offered digital ordering for over a decade. The company reports that now 60% of orders come through digital channels – over half of those through mobile devices alone – as customers embrace Domino’s digital ingenuity.
But, according to a news release, the company wants to shift more of its business online.
Managements asks. “How can we convince even more customers to give digital ordering a try?” The answer could have been the catalyst for a stock market sell off, “Fifty percent off all online pizza orders!:
The company dedicates a surprisingly high percentage of its overhead to the digital side of the business:
“About half of the people at our headquarters work in developing and supporting the digital side of the business, which allows the stores to focus on creating amazing food and delivering the best customer experience, with less time spent on the phone taking orders,” said a company spokeswoman.
She continued, “With 50 percent off online pizza orders, hungry customers who haven’t tried out digital ordering might just succumb to the tempting price and maybe discover online ordering is easier than they thought.”
The 50% off deal is only available on menu-priced pizzas ordered through any of Domino’s online ordering channels which include Domino’s website (dominos.com), as well as Domino’s ordering apps for iPad, iPhone, Android, Windows Phone 8 and Kindle Fire. The deal runs through December 7.
This means Domino’s is sacrificing half of its revenue for 11 days, and that seemed to concern traders who reacted to the news by selling the stock.
Traders seem to be questioning why the company needs to offer such a steep discount for such a long period of time.
Domino’s Pizza ranks among the world’s top public restaurant brands.
The company has a global enterprise of more than 14,400 stores in over 85 international markets.
Domino’s had global retail sales of nearly $10.9 billion in 2016, with more than $5.3 billion in the U.S. and more than $5.5 billion internationally. In the third quarter of 2017, Domino’s had global retail sales of more than $2.8 billion, with nearly $1.4 billion in the U.S. and over $1.4 billion internationally.
Its system is comprised of independent franchise owners who accounted for over 97% of Domino’s stores as of the third quarter of 2017. Emphasis on technology innovation helped Domino’s reach an estimated $5.6 billion in global digital sales in 2016.
The digital business has produced several innovative ordering platforms, including Google Home, Facebook Messenger, Apple Watch, Amazon Echo, Twitter and text message using a pizza emoji.
The company is also entering the next frontier of technology.
In late 2017, as part of an industry-first collaboration with Ford Motor Company, Domino’s Pizza began a meaningful test of delivery using self-driving vehicles.
This news has at least one bit of good news for traders. The stock has become more volatile.
Higher volatility is generally associated with higher options prices.
This is because options prices reflect a number of factors. The price of a call or put option is affected by the price of the underlying stock, the current level of interest rates, the time left to expiration and the volatility of the underlying stock among other factors.
Increased volatility, when it leads to increased options prices, sets up a number of potential trading opportunities for options traders.
A Strategy to Trade Domino’s Pizza
Domino’s Pizza (DPZ) is likely to remain in a relatively narrow trading range while investors wait for news on how the steep discounts are affecting the company’s bottom line. This indicates a significant move in the stock price is unlikely.
When a stock is expected to remain in a narrow range for some time, it is possible to generate income from the stock.
A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which recently saw increased volatility and is likely to remain in a narrow range.
Source: The Options Industry Council
This strategy involves two put options.
One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call. That objective is to generate some income. This trade generates immediate income and carries limited risk.
For Domino’s Pizza, a bull put spread could be opened with the December 15 put options.
This trade can be opened by selling the December 15 $165 put option for about $1.50 and buying the December 15 $160 put for about $0.75.
This trade would result in a credit of $0.75, or $75 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $5.00 ($165 – $160). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $425 ($500 – $75).
The potential gain is about 17% of the amount of capital risked.
This trade in Domino’s Pizza (DPZ) will be open for about one month and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives.
In this trade, options provide income and defined risk that could be lower than owning the Domino’s Pizza stock. This strategy could also simplify tax reporting for investors.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service.