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Jared Woodard Trade YUM: Hungry for Emerging Markets Exposure

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Freu d's famous cigar quote is all about how sometimes, there's no deeper meaning to an event. In a great discussion of the backstory to this emerging market selloff, Matthew O'Brien takes a similar tack: "Lehman conditioned us to always look for the next domino. But sometimes a falling currency is just a falling currency." Jim O'Neill, former GS Asset Management chairman, expressed a similar outlook today: "Some places in the emerging world have got some real problems, but [for] that to be described as some kind of emerging-market crisis is frankly kind of ridiculous."

If you're inclined to start dipping into some names where the market decline has pushed prices too low, one approach to take is to look for U.S. stocks that have high exposure to sales in emerging markets.

Yum! Brands (YUM) is one such candidate. About 60% of YUM sales come from emerging markets, according to data from BofA Merrill Lynch, and the stock is reportedly under-owned by large cap U.S. mutual funds. On Monday, the company announced that it beat quarterly earnings estimates, and the stock closed up nearly 9% on Tuesday. Jim and Stephanie have a great review of the fundamentals posted at AAP.

Option volume was 330% the daily average on Tuesday (nearly 54,000 contracts traded) as traders piled into calls, buying 560,000 in net deltas. Option implied volatility dropped post-earnings, but March and April IV actually rose about a full percentage point between the open and the close.

If we take out earnings jumps, the one month realized volatility in YUM tends to be around 20%-25%. March and April options are priced around those levels, so I think prices are fair here. But if analysts do start raising estimates, broad market sentiment improves, and the stock multiple catches up with the sector average, we should see higher prices in the coming months.

Trades: Buy to open YUM April $72.50 calls for $2.62 and sell to open YUM April $77.50 calls at $0.83.

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At the time of publication, Jared Woodard held no positions in the stocks or issues mentioned.

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