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The No. 2 soda maker in the United States and the world's largest snack food maker, Pepsico (NYSE: PEP), looks like an emerging market play, particularly on the resurgence of Latin America. While U.S. soda sales have flat-lined for all of the major players, overseas sales account for about half of Pepsico's revenue, and the growth there has been strong.
The company recently reported Q1 earnings that beat analysts' estimates, helped by global snack sales. Its Latin America Foods division grew net revenue by 11%, and management stated, "We had terrific growth across each of our major developing markets with organic revenue growth of 6% in Mexico, 8% in Turkey, and 12% in Brazil."
Prior to the breakout in February, PEP shares had traded between $58 and $74 since 2009. This $16 range targets a move to $90.
The $90 target is about 9% higher than current prices, but traders who use a capital-preserving, stock substitution strategy could see gains of almost 75% on a move to this level.
One major advantage of using long call options rather than buying a stock outright is putting up much less capital to control 100 shares -- that's the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.
Simply put, you want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:
Rule One: Choose an option with a delta of 70 or above.
An option's strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)
It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they're worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.
The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option's delta using an options calculator, such as the one offered by the CBOE.
With PEP trading at about $82.45 at the time of this writing, an in-the-money $75 strike call option currently has $7.45 in real or intrinsic value. The remainder of the premium is the time value of the option. And this option currently has a delta of about 80.
Rule Two: Buy more time until expiration than you may need -- at least three to six months -- for the trade to develop.
Time is an investor's greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.
With these rules in mind, I would recommend the PEP Jan 2014 75 Calls at $8.60 or less.
A close below $74 in the stock on a weekly basis or the loss of half of the option's premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $860 or less paid per option contract. The upside, on the other hand, is unlimited. And the January 2014 options give the bull trend almost nine months to develop.
This trade breaks even at $83.60 ($75 strike plus $8.60 options premium). That is a little more than $1 above PEP's current price. If shares hit the upside breakout target of $90, then the call options would have $15 of intrinsic value and deliver a gain of almost 75%.
Recommended Trade Setup:
-- Buy PEP Jan 2014 75 Calls at $8.60 or less-- Set stop-loss at $4.30-- Set initial price target at $15 for a potential 74% gain in eight and a half months
The bar has been set extremely low, and the tech giant should have no trouble clearing it.
A breakdown below an important trendline could trigger a double-digit drop in shares.
This week, we have an opportunity to capture even more income on a stock we already own...