Go Long Chipotle Mexican Grill, Inc. (CMG) Stock, But Leave Room for Error
So far, 2017 has not been kind to Chipotle Mexican Grill, Inc. (NYSE:CMG) stock. It’s down 18% while the equity indices have been setting all-time-high records on a consistent basis.
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It’s not simply traders being fickle. Some of the downturn is self-inflicted.
While Wall Street had almost forgotten about CMG’s two-year-old health disaster headlines, new ones have recently resurfaced with new sickness incidents. To make matters even worse, they even had a video of rats falling out of the ceiling of one store go viral.
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This negative exposure is poison to the company’s marketing efforts. Management has been over-spending there to fix their comp sales performance, but to no avail. These incidents will set them back even further. Comp sales was the reason that traders overpaid for the stock. Without it, CMG is just another restaurant undeserving of a 60 PE.
In addition, McDonald’s Corporation (NYSE:MCD) has emerged as the new favorite on Wall Street. They can do no wrong and the stock has captured bids away from fallen angels. The tide is against CMG stock, and they need a miracle to resurface as a star. I doubt that the stock can ever go back to what it once was.
Meanwhile, fundamentally Chipotle is still bloated. Its price-to-earnings ratio, although is it has recently taken a 50% haircut, is still too high for me to buy the shares at face value. But I can bet on its price action for the next few months. I do this using options.
Technically, CMG stock has already had two prior 50%-plus corrections — one in 2012 and the second in 2015. This drop here is nearing 40% so it’s entirely possible that it too hits 50%. Last April, Chipotle stock lost an ascending trend and I had $320 per share as its estimated target. It took a while but here it is just below that.
CMG is still a falling knife with no obvious end in sight. The valuation is still too expensive relative to its sector. To illustrate the point consider MCD stock, which has rallied 38% in 12 months and yet still has a trailing P/E of 28. CMG’s PE is still about three times bigger. So there is a lot of potential air to deflate from the premium.
CMG Stock Trade Idea
The Bet (And This IS a Bet!): Sell the CMG Dec $220 put and collect $2.25. Here I have an 85% theoretical chance of retaining maximum gains. However, if price falls below my strike, I would own the shares and accrue losses below $218. This is a speculative trade with tight stops. I don’t want it to turn into an investment.
Selling puts in a stock this expensive is margin-intensive. I can greatly limit this risk by selling credit spreads instead.
The Safer Bet: Sell CMG Dec $230/$220 credit put spread, where I have about the same chance of winning but with much less risk. If it wins, the spread will deliver 8% in yield.
When investing in the stock market there are no guarantees. So I never bet more than I can afford to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
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