As inflation rages and interest rates push higher, defensive stocks have started to show some weakness. Coca-Cola, while outperforming earlier this year, has been in a slow downtrend since August. Investors who expect further weakness in the stock can consider using a bear put spread to express this view.
To construct a bear put spread, simultaneously buy a put and sell a put at a lower strike price with the same expiration. For Coca-Cola stock, investors can consider buying a 60 put while selling a 50 put, both with a Nov. 18 expiration.
To place the trade investors will pay a debit of $4.30. This coincides with a maximum loss of $430 for a block of 100 shares should Coca-Cola trade above 60 on expiration. The maximum gain is the width of the strikes minus the debit paid. In this case, a maximum gain of $570 (10-4.3 x 100) will be realized if Coca-Cola trades below 50 on expiration.
High Put Skew Allows For Attractive Risk/Reward
While this trade initially has little exposure to volatility, it does have some exposure to Coca-Cola's high put skew. This allows a trader to buy the 60 put at lower implied volatility than the 50 put. While Coca-Cola normally has put skew, a comparison to the current skew on the S&P 500 suggests the put skew on Coca-Cola may be overpriced.
Coca-Cola has been a bellwether for conservative dividend investment portfolios, boasting 59 straight years of dividend increases. Nevertheless, with a price-earnings ratio of 25, the current valuation could be stretched and is far less appealing now that fixed income provides a strong alternative to the company's 3.1% dividend yield.
The company faces various headwinds to justify this valuation, including higher inflation, declining soft drink sales and a stronger U.S. dollar. That could harm the company considering two-thirds of sales are derived from international markets.
It is important to note that thus far Coca-Cola has displayed strong resiliency and done an excellent job in diversifying its product base in soft drink alternatives.
Coca-Cola will report its third-quarter earnings on Oct. 25. Analysts expect EPS of 65 cents with revenue of $10.52 billion.
Despite being down only 5% year to date, shares of Coca-Cola are nearing 52-week lows, trading below both the 50-day and 200-day moving average lines.
