Value Options: Get Paid to Wait for McDonald’s Stock (Selling Puts Explained)

During their recent episode of the Value Options Letter and Acquirers Podcast, Travis and Carlisle discussed:

• McDonald’s Isn’t a Burger Company — It’s a Landlord
• Two Advantages of Using Options
• The Wheel Strategy Explained Using McDonald’s Stock
• Why Value Investors Sell Options When a Stock Has Clouds
• How Options Help Value Investors Get Paid While They Wait

TRANSCRIPT

[Tobias] Hi, I’m Tobias Carlisle. This is the Value Options Letter podcast. I’m joined as always by my co-host, Tim Travis.

How are you, Tim?

[Tim] I’m good, Toby. How are you?

[Tobias] I’m well. It’s interesting week in the markets this week. Interest rates have been jacking up globally and that seems to maybe be beginning to weigh on equity markets a little bit.

The other thing that we’ve seen is real estate seems to have been a little shaky and that’s also maybe connected to real estate, maybe connected to interest rates. How do you see it?

[Tim] I know, I would agree. I think that every time that the war kind of spouts off again, people get discouraged that the timeline for resolution gets longer and dragged out and so more inflationary pressure on the economy. And I think Scott Besant had an announcement where the amount that the Treasury is gonna be buying of long-term bonds was a little disappointing to the market or whatever.

So you have Treasury yields and long bond yields that are approaching the highest levels they’ve been in quite some time. So that’s a big negative for the market overall. And it’s a negative, I think you’re seeing that volatility reflected in more broad swings, a lot of tech stocks kind of selling off a little bit too.

But yeah, real estate definitely is impacted heavily by that.

[Tobias] One of the positions that we had on McDonald’s traded down and as we always say, there’s always two outcomes with these positions who either get put the stock or the option expires without being, it expires worthless in which case you collect the premium. In this instance, we got put the stock in McDonald’s as everybody knows McDonald’s is a big real estate player and you get the restaurants thrown in for free. So what happened with the McDonald’s position?

McDonald’s Isn’t a Burger Company — It’s a Landlord

[Tim] Yeah, so we sold a 260 put and we collected something around like $3.50 or something. It was a relatively shorter term trade. I mean, McDonald’s is at the 52 week lows right now.

So we’ve been watching it for a while and the valuation was a little too rich for us. And it finally got to a level where we’d be willing buyers. And so I was actually really pleased to get exercised on that, the dividends about 3%.

And like you said, a lot of people think that the values, roughly $100 billion worth of real estate in that portfolio. And as much as people hate on McDonald’s, I’ve almost written it off in my head so many times where people are just gonna kind of stop going there and they don’t. I mean, being a father as I know you are too, you know, my kid’s favourite burger place is McDonald’s to go to.

Whether we let them go to it or not is open for discussion. But you know, it does have tremendous brand and franchise value. So the valuation is much more compelling with where it’s at now.

And I don’t think you have, I mean, obviously they’re not gonna liquidate their real estate likely in the near future. So that’s not the play. But when you’re buying it at a high teens, earnings multiple and a reasonable dividend well in excess of what you can get in the S&P 500.

And they are growing and they have some levers to pull where they should be able to continue to do that for quite a long time. It’s an easy to understand business. And so what we did though was we turned it into, so we were exercising our put at 260.

Our break even, I don’t have it off the tip of my fingers, probably like 266, something like that. And then we sold a call that’s also relatively short term, like 45 days out at 265 and collected a really nice premium. So the annualised return is really good if we end up getting called away at 265.

If not, we can continue to do that. And even if we didn’t sell the call, I’d be comfortable just owning the stock outright. But you know, it’s an options trading subscription.

And so that’s part of the play.

Two Advantages of Using Options

[Tobias] So that’s just a little illustration of what happens with these positions. There’s always, whenever we put a position on, there’s always two outcomes. You get put the stock at a price that you want to own it or the option expires worthless and you collect the premium.

If you get put the stock, then it opens up new opportunities for new strategies. And one of them is the wheel. And that’s where you either just do the same trade again, sell another put to get further into the stock or sell a call because you’re already long with stocks that turned into a covered call.

What do you think about the likely trajectory of McDonald’s in the shorter term? Do you have any view there?

The Wheel Strategy Explained Using McDonald’s Stock

[Tim] I mean, I’m optimistic on it because I think the valuation is compelling. I think that the brands there and with people paying so much for gasoline right now, I think the lower cost menu offerings that they have are attractive to consumers that are looking to save. So I’m optimistic long-term and short-term.

But I think using the options is an effective way because don’t forget when we were selling the 260 puts, the stock’s at, it was at like 270, 267. So instead of taking that full hit, and of course the 52-week high is well over 300, instead of taking that full hit, you’re down a couple bucks on your 100 shares and then you have the options capabilities to sell covered calls from there. So I feel like the volatility was attractive.

We’re happy collecting dividends if we own the stock long enough and we think that there’s enough upside. There’s plenty of premium available on the calls. So it’s a dynamic strategy where we know what we own, we know why we own it, and we know at what prices we’re comfortable buying or selling.

And so that plays to our advantage. We have the knowledge behind us. It’s not just kind of at the fly, off the cuff.

You know, it’s an educated strategy.

[Tobias] When rates jack up like this, it impacts the market, also impacts real estate, tends to be quite interest rate sensitive for the obvious reasons. How are the rates looking?

[Tim] I mean, rates look really attractive. So you have a lot of these that historically have traded at 18 to 20 times cash flows, and now you can get them at 10 to 12. A good example of that is Veitchi Properties, which we’ve talked about before.

You’ve got Veitchi trading just above 25. It’s kind of been in a range of like 28 to 32 the last few years, with some dips, and those dips have been good buying opportunities below that. But right now with nearly a 7% dividend yield, they own most of the really key casinos in Vegas, and they own really good regionals.

Vegas is rebounding from a tough year last year, and they’re doing quite a bit better. So I just think it’s an issue where rates and short-term concerns on like the uncertainty with Caesars, if they’re gonna be bought by Fertitta, is dragging on the stock. And then management did something I don’t like.

I hate when companies do this, but they were asked about should they buy back stock. And this wasn’t even in the earnings transcript. It was in an interview I saw, and it’s like, well, it’s really tough for a REIT to do that, blah, blah, blah, blah.

And it’s like, I just don’t think that’s ever the right answer. I think the right answer is at the right valuation, absolutely we will. We look at the biggest benefit to shareholders, and if that’s buying back stock, that’s what we’re gonna do.

That’s just a way better answer. So I think that people, that would be an immediate catalyst. Like, hey, look, our stock’s too cheap.

We’re gonna buy it back. 7% dividend yield’s ridiculous for a company of this high of quality. They have annual inflation adjustments to their leases.

Even during COVID, 100% of their lease roll was paid, et cetera, et cetera. So I think there’s numerous opportunities in that arena. And there’s quite a few real estate trades on the website currently.

Why Value Investors Sell Options When a Stock Has Clouds

[Tobias] It’s worth pointing out that the time to enter into these positions is usually when there’s some overriding concern about the business. These opportunities are only presented when the positions are, there’s some perception that there’s something, the matter with the stock.

[Tim] There’s clouds, there’s clouds, right? Yeah, you gotta have clouds.

[Tobias] A good example of that was last year when energy around this time, maybe a little bit later, WTI oil was trading at $60, 60 handle. And all of the pundits were saying it’s going lower from here. And oil equities traded down very cheaply.

And the future is unclear at that point, but historically there’s been some event that’s come along with energy equities and bumped them along. And sure enough, that happened with the conflict in Iran. I just think it’s a good example of just ignoring the headlines, looking at the fundamentals of the stock, looking at the, and the headlines can be great for an option service when they inject some volatility, which then increases the yield that you can pull out of these options.

How does that sound?

[Tim] Oh, you’re right. I mean, it was prior to the website being launched, but I remember last year buying a lot of MLPs that had 8% dividend yields. And it’s like you were alluding to, there was excess supply of natural gas and crude oil.

And then OPEC was going to increase their quotas. It was a lot of negative elements on the overall price. And like you said, the stocks got pretty cheap and they’ve gone on a huge run, the MLPs included.

We’ve had a number of energy trades on the site that have been successful. And we’re constantly looking for opportunities. Obviously a little pullback would be ideal for something like that.

But that’s, your point is exactly right. Like you and I as value guys, we could both look at like a stock like Avicii and we might have slightly different numbers, but I think we would both probably agree that the stock’s undervalued at the current price. You know, is 10 times cash flows the right price, 7% dividend yield for a company of that quality?

Probably not. But the timing is the issue, right? So it’s like, well, what if rates go to 4.15 on the 10-year?

You know, that could cause the stock to dip to 23. And, you know, if you have a long-term time horizon, truthfully, you still buy it, right? You’re still buying it even though you can’t predict that short-term.

How Options Help Value Investors Get Paid While They Wait

And we don’t try and predict the short-term per se, but we utilise the option. So, I mean, you know, for me personally, I own that stock, but I also have covered calls at certain levels and I also have cash secured puts at certain levels because there’s a lot of ways to skin a cat. And I know that my timing might not be perfect, but if we can dollar cost average in, collect a little bit of additional income, still have some potential for upside, that makes sense.

So on a long-term view, look, if you have a five-year time horizon or God forbid 10 years, I mean, buying some of these really high quality commercial REITs, I’m not talking about like office buildings, but like at these valuations is likely to do quite well and barring the worst hyperinflationary type scenarios.

[Tobias] And on that note, folks, if you’re interested in trialling services, it’s free for seven days to trial it. You just head over to valueoptionsletter.com slash subscribe and check it out for nothing for seven days. Any final words, Tim?

[Tim] Nope, we’re good. See you next week. Looking forward to it.

Looking forward to the NFL kicking off. It should be a fun weekend for football.

[Tobias] Yeah, I just had the draft this weekend. Should be a good one.

[Tim] All right, you’re ready. See you guys.