UPDATE 1-Growth concerns behind bearish options bets in Yum

Wed Jan 25, 2012 10:45pm EST

* Yum February $60 puts stand out

* Yum overall options volume above the norm this week

By Doris Frankel and Lisa Baertlein

CHICAGO/SAN FRANCISCO, Jan 25 (Reuters) - Option investors appear to have worries about Yum Brands Inc , taking out protection against a share price decline ahead of the fast-food chain's quarterly report early next month, analysts say.

Prospects of slowing Chinese growth and unfavorable exchange rates, the same headwinds that threaten rival McDonald's Corp , are worrying investors in the fast food purveyor.

China, the world's fastest-growing major economy, is Yum's top market for revenue and profit and the company's KFC chain is the top Western restaurant brand there.

"Yum's option action today in all likelihood reflects the strengthening U.S. currency market and the headwinds that might create for corporate earnings," said Michael Yoshikami, founder and CEO of YCMNET Advisors, whose fund owns McDonald's and tracks Yum.

"Though China continues to be a growth engine for corporate earnings, the slowing Chinese economy -- now at 8.5 percent (growth) -- means that rampant Chinese growth cannot be counted on to drive earnings even for well-positioned global companies like Yum," he said.

A flurry of put action in Yum occurred in the aftermath of McDonald's quarterly earnings report on Tuesday. The demand for puts, contracts that grant investors the right to sell shares at a fixed price any time up until expiration, continued on Wednesday, sending Yum's options volume to above typical levels in both sessions.

With these stocks trading near all-time highs, it is not surprising to see shareholders either looking to protect gains or traders making an outright bearish bet by buying near-the-money front month put options, notably in Yum, said Dan Nathan, a founder of riskreversal.com, a New York-based firm specializing in options trade ideas.

"For these fast-food vendors, most of their growth comes overseas as North American markets have matured," Nathan said. "Both companies face significant headwinds ranging from unfavorable exchange rates to higher input costs that could hurt their profit margins."

Shares in both fast-food names are expensive. McDonald's trades at about 20 times earnings, whereas Yum trades at almost 25 times earnings, said TD Ameritrade chief derivatives strategist J.J. Kinahan.

Most of the put action in Yum was in the put conveying the right to sell the shares at $60 apiece by February expiration. On Wednesday, its shares closed up 38 cents at $62.65, near its all-time high of $63.44.

"We are seeing aggressive buyers of the February $60 Yum puts," Kinahan said. He noted that big buyers of those puts came in on Wednesday morning and since then, the puts have been purchased in smaller lot sizes.

"One of the reasons for the put buying in Yum may be tied to the worries that were expressed by McDonald's on Tuesday," Kinahan said.

McDonald's reported unexpectedly strong December sales at established restaurants, but its shares slipped after it said exchange rates and other costs could take a bite out of profits in 2012.

Foreign exchange boosted McDonald's earnings by 19 cents per share in 2011 and will work against the company by roughly the same amount in 2012, analysts said.

Yum, based in Louisville, Kentucky, has roughly 4,200 restaurants, mostly KFC outlets, in China. The company, which also owns Pizza Hut and Taco Bell Brands, has far more restaurants than competitors such as McDonald's and Starbucks Corp. The company did not immediately respond to requests for comment.

Yum and McDonald's lately have benefited from the weak U.S. dollar, which makes U.S. goods more affordable overseas, but that impact is likely to reverse as the dollar strengthens versus other currencies.

China's yuan currency rose 1.5 percent against the dollar in the fourth quarter and offshore forwards markets are pricing in a further rise of 0.9 percent in the coming 12 months.

The euro fell more than 3 percent against the dollar in the fourth quarter and a Reuters poll on January 5 predicted a further 2 percent fall in the first half of this year.

McDonald's also said that building new restaurants in China took a bite out of margins during the fourth quarter.

"We believe this impact is temporary and remain very bullish about the long-term potential of this market," McDonald's Chief Financial Officer Pete Bensen said on a conference call with analysts on Tuesday.

Overall volume in Yum options on Wednesday was three times the average daily turnover, with about 13,000 puts and 1,715 calls traded, options analytics firm Trade Alert said. On Tuesday, the turnover was 11.8 times normal levels, with 33,000 puts and 3,957 calls changing hands.

Yum is scheduled to report quarterly results on Feb 6.

McDonald's is also trading near its historical peak of $102.22. The stock closed up 49 cents at $99.23.

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