Papa John’s Unusual Options Activity Suggests a Long Strangle Might Be in Order

Even though I’ve been writing about options for over two years now, I continue to remind myself that relative to the amount of time options have existed -- the use of options is said to date as far back as 332 B.C., but the modern origin is the creation of the Chicago Board of Exchange (CBOE) and the Options Clearing Corporation (OCC) in 1973 -- I’m a newbie. I know enough to know how much I don’t know. 

So, today, I’m getting out of my comfort zone and proposing that owners of Papa John’s International (PZZA)stock consider a Long Strangle, something I’ve never written about before, based on Wednesday’s unusual options activity. 

Yesterday, there were 1,018 unusually active options—defined as a Vol/OI ratio of 1.24 or higher and expiring in a week or more—with the highest Vol/OI ratio being the Apple (AAPL) June 21 $212.50, put at 276.32. 

Pappa John’s had two unusually active options yesterday.

There are several things that make for a Long Strangle:

1. You have a call and put with different strike prices. 

2. They have the same expiration date. 

3. Both are OTM (out-of-the-money).

4.  They are for the same stock.

I must admit I haven’t covered Pappa John’s in ages but the Long Strangle jumped out at me, so away we go. 

PZZA Stock Down 36% YTD

The company’s share price closed 2023 at $76.23, down 7.4% on the year. Through the first half of 2024, it lost another 36%. It now trades where it did five years ago. 

A key to a Long Strangle is that you’re betting the stock will make a big move, but you’re not sure in which direction. Before committing to such a bet, I’d examine the state of the pizza franchisor’s business. That will help confirm if a big move in either direction could be in the offing. 

First things first, of the 15 analysts covering PZZA stock, 7 consider it a Strong Buy (3.93 out of 5) with a $69 target price, 44% higher than where it’s currently trading. This suggests that analysts generally view Papa John’s in a favorable light. However, the Barchart Technical Indicator says it’s a Strong Sell in the near term. 

The company reported Q1 2024 results on May 9. Revenues were down 2.5% to $513.9 million, $30.6 million lower than the analyst estimate, its biggest revenue miss in more than five years. On the bottom line, it earned 67 cents on an adjusted basis, 10 cents better than the Wall Street consensus. Restaurant-level margins improved by 220 basis points. 

Papa John’s same-store sales in the quarter declined 2% overall, with a 3% drop for its company-owned locations, a 2% decline for North American franchised locations, and a 3% drop for its International business, which includes both company-owned and franchised locations. According to the company, fewer transactions from Q1 2023 were the culprit for lower same-store sales growth. 

In March, long-time CEO Rob Lynch became CEO of Shake Shack (SHAK). CFO Ravi Thanawala became interim CEO while the company searched for Lynch’s replacement. 

“In the current environment, we’re also seeing customers become more deliberate in managing their overall order costs,” Thanawala said in the Q1 2024 conference call. “So while our core offering pizza remained higher year over year, sides and beverages were lower.”

Investors' top two concerns are: When will the North American macroenvironment get stronger, and who will be the new CEO?

Until those are answered, it would seem that there are few catalysts to return PZZA stock to the $70s. 

The Risk/Reward Is Good

On the surface, a Long Strangle isn’t warranted in this situation because I don’t get the feeling a big move either way is in the cards over the next 36 days. However, let’s consider the financial cost of the trade before ruling it out. 

Based on the call ask price of $0.65 and the put ask of $0.60, the total cost is $125. Of the two, the put is less out of the money ($575) than the call ($805).  

Let’s assume the stock price moves $10 in either direction by the July 19 expiration. Based on a $47.60 share price as I write this, the put and call would be $430 and $195 in the money, respectively. 

So, the share price for the put has to fall 12% to break even while it has to move 17% higher to break even. 

From where I sit, the put looks like the better play in the near term. In the long term, once a good CEO is announced, I don’t think you’ll see PZZA shares in the $40s for too much longer. 

The Long Straddle is more appropriate when there is an imminent event that will move the share price in the near term. In Papa John’s case, there is a bullish event possible in the next 36 days (CEO hiring) but there’s not a definitive negative event other than it continuing its slide in 2024. 

It’s not perfect, but given the $125 outlay is low, it’s worth considering.