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Use the ‘Monty Hall’ Methodology to Grab a 47% Payout in Yum China (YUMC) Stock
At first glance, technical indicators appear to contradict underlying fundamentals for franchised restaurant brand Yum China (YUMC). Focused on the Chinese consumer market, the company’s powerhouse labels include KFC, Pizza Hut and Taco Bell. Ordinarily, an investment in YUMC stock would be considered a reliable and predictable one; after all, who doesn’t like fast food?
Ironically, though, the shocking election of President-elect Donald J. Trump on the surface poses significant challenges for Chinese equities. As you know, “The Donald” is a huge (or “yuge”) fan of fast food. However, he’s not exactly the biggest supporter of China. With Trump returning to the White House, fears of a trade war initially clouded the Asian juggernaut’s financial markets.
Still, a silver lining appears to have sprouted. As the AP reported recently, China was on the verge of announcing much-anticipated steps to boost its softening economy hours after Thursday’s U.S. market close. Previously, analysts remarked that aggressive measures would need to be implemented to catalyze the world’s second-largest economy. Unlike the U.S., China hasn’t really bounced back from the COVID-19 crisis.
Further, it’s important to look beyond Trump’s unorthodox rhetoric. Let’s call a spade a spade: the fears of a second Trump term messing up the global order is strong precisely because of the man himself. However, past precedent has also revealed that Trump is willing to hash out disagreements with Beijing. Thus, circumstances might not be bad for YUMC stock — they might even be positive.
J-Hook Screener Spotlights YUMC Stock
Interestingly enough, one of my favorite Barchart screeners — the enticing J-Pattern or J-Hook — identified YUMC stock as an upside opportunity. Named for the shape of its chart pattern, the technical formation implies an upward trajectory following a brief period of consolidation or pullback. Below is the basic anatomy:
- Initial uptrend: The target security experiences a strong upward movement.
- Pullback/consolidation: Following the initial rise, the stock encounters a brief pullback or sideways consolidation phase.
- Rebound and breakout: After this consolidation period is over, the security begins to rise again, forming the “hook” component of the J-Pattern.
If you agree that both the technical and fundamental catalysts are net positive for YUMC stock, then you have a couple of choices. You may buy the security outright, which is the simplest approach. The next idea is to consider a long-expiry call option. Finally, the point of this article is high-risk, high-reward speculation: buying a near-expiry bull call spread.
This options trade utilizes the credit received from a sold call at a higher strike price to help offset the debit paid of a lower strike call. In a way, you’re getting a discount on a call option while sacrificing on the other end with capped maximum profits. However, my argument is that if your option expires very quickly, the capped return is a very reasonable tradeoff.
Using the Monty Hall Approach to Picking Your Spread
For those who are Barchart Premier members, you can pull up the available bull call spreads of any optionable security for any expiration date. Regarding YUMC stock, we’ll go with the nearest expiration date, which is Nov. 15. Here, we’re presented with five bull call spreads, which raises the obvious question: which one to pick?
This is where the Monty Hall approach is useful. The Monty Hall problem is a classic brain teaser featured in several educational and pop-culture references, including in the film 21. Essentially, you’re asked to choose between three doors, with one revealing a prize. The gameshow host then reveals one of the non-prize doors and gives you the opportunity to switch, should you choose.
Statistically, it’s always better to switch because originally, the door you chose had a 66.67% chance of being incorrect. So, by switching, you have a 66.67% chance of being correct. And even if you incorrectly assumed that the odds of winning have only increased to 50%...well, guess what? A 50-50 guess is a lot better than two-thirds odds of being wrong.
How does this relate to our YUMC stock bull call spreads? We don’t look for the best spread right away but rather eliminate the worst ones. Right off the bat, we know that the 47.50C/55.00C is terrible because it requires a high cash outlay ($515) and the gap to breakeven stands at 2.31%. We can also eliminate the 50C/55C and 52.50C/55C spreads because their average gap to breakeven stands at a less realistic 2.65%.
We’re left with the 45C/55C and the 50C/52.50C spreads. Of these, I prefer the latter since YUMC stock only has to reach $52.50 to receive the maximum payout of 47.06%. The cash outlay of $170 is also significantly lower than the $645 necessary for the former.
And that, my friends, is how you use Hollywood movies to your advantage.
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On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
