Happy Friday. It's the end of another workweek. Boy, this week was long, given all the market craziness. As I write this, the S&P 500 futures are up just before the markets open. Let’s hope it stays that way and we finish the week on a high note.
Between the potential government shutdown, tariffs, and all the other things happening in Washington right now, volatility is the modus operandi of the markets, and it will likely remain so for the foreseeable future.
The University of Michigan U.S. Consumer Sentiment Index will be released today. The economist's average forecast for March is 63.1, down from 64.7 in February. This low was last seen in November. However, we still have a ways to go before we reach the five-year low of 50.0 in June 2022.
I don’t know about you, but I could see it happen quickly once the tariffs bear their teeth over the next few months. As Canadian Prime Minister Jean Chretien said recently at the election of the Liberal Party’s new leader, “Stop this nonsense.”
Onward.
In yesterday’s unusual options activity, restaurant software provider Toast (TOST) had a call and a put in the top eight spots. With the same expiration and strike prices, a straddle jumps to mind.
The question is whether the play is long or short. Here’s my thoughts on the matter.
Have an excellent weekend.
The Unusual Options in Play
There were 1,342 unusually active options yesterday--defined as a Vol/OI ratio of 1.24 or greater and expiring in seven days or more--Toast had a call and put in the top eight spots.
I considered the American Eagle Outfitters (AEO) April 17 $10 put because I’m an avid follower of retail stocks. It had a Vol/OI ratio of 222.06, 4x the second-highest. Still, I went with Toast, a company I like, because a straddle play was plain as day.
Here’s Barchart’s explanation if you’re unsure what a straddle is:
“The long straddle strategy anticipates volatility to rise and the underlying security to move significantly in either direction. The long straddle option strategy involves buying a call and a put option at identical strike prices.”
As you can see from the image above, the strike price for both is $25, and both expire on June 20, 99 days from yesterday. But as I say, the question is whether the play is a long or short straddle.
Let’s consider both and then I’ll return to the options.
A Slowdown in Consumer Spending Is Bad for Toast
At 2 p.m. yesterday, with just two hours of trading left, TOST stock was down 7.1%. It ultimately finished down a little over 6%. As I write this, it’s up over 2%, attempting to claw back some or all of its losses from yesterday.
Investors are concerned about how tariffs will affect consumer spending. That’s a legitimate concern, so there has been so much volatility over the past week. People are wondering if they’ll have jobs in a month, and even if they do, will they be able to afford the higher prices due to Trump’s tariff plan?
It’s easy for a billionaire like Trump and Treasury Secretary Scott Bessent, also wealthy, to have this to say, “We're focused on the real economy.... I'm not concerned about a little bit of volatility over three weeks.”
Now, Bessent’s speaking about market volatility, not economic volatility, but in the end, they’re the same thing if a recession hits.
Specifically addressing Toast, it generates a big chunk of its $4.96 billion in annual revenue from payment processing fees, which the company says in its 2024 10-K is “calculated as a percentage of the total transaction amount processed plus a per-transaction fee.”
In 2024, its Financial Technology Solutions segment accounted for 82% of its revenue. While there are some other fees within the $4.05 billion generated, most would be from processing transactions for restaurants.”
If people stop going to restaurants, or at least, slow the visits, Toast’s big moneymaker takes a hit.
The Concern Is Overstated
Consider that restaurants in the U.S. started closing in March 2020 due to the pandemic. Most were reopened by June 2020. That’s three or four months.
According to S&P Global Market Intelligence, the company’s Q2 2020 revenues were $145.2 million, down from $171.9 million in the previous quarter. Yes, there was an effect, but not a big one, so you can argue that the tariff effect isn’t nearly as consequential as investors think.
That said, America hasn’t been in a recession since the pandemic, so there is no near-term example of how a downturn affected the company. Therefore, one can only estimate the damage.
Suppose Toast’s revenue is cut by 15% due to a tariff-induced recession. That would reduce its annual revenue to $4.22 billion, the second-highest in its history.
Toast only went EBIT (earnings before interest, taxes, depreciation and amortization) positive in 2024. A 15% cut in revenue would likely return it to EBIT losses for at least a quarter or two. That will affect its valuation and its share price.
However, the call and put expire in June. The full effect of the tariffs won’t be realized until later in the year, and that’s assuming Trump doesn’t come to his senses.
In the long term, the business will remain a good one.
Back to the Straddle
Which would I do? A long straddle or a short straddle? Let’s consider both.
Starting with the long straddle, the first thing to determine is the net debit, or the cost of the bet. Using yesterday’s example, it is $9.97 [$8.95 ask price for call + $1.02 ask price for put]. That’s 30.6% of the stock price. It’s the maximum you can lose.
The next thing to determine is the breakeven price at expiration.
On the upside it is $34.97 [$25 strike price + $9.97 net debit] and $15.03 [$25 - $9.97] on the downside. Based on yesterday’s closing price of $32.61, you’re 7.2% from the upside breakeven of $34.97 and 53.9% from the downside breakeven of $15.03.
While anything’s possible, I don’t think its shares will fall to $15.03, to make money on the downside. It hasn’t traded below $15 since November 2023. On the other hand, in this market, it’s hard to see any stock gaining much over the next three months.
Now let’s consider the short straddle. It involves selling the $25 call and put. In the long straddle you wanted volatility. In the short, you want the share price to stay in a tight range.
The first thing to determine is the net credit, or the premium on the bet. Using yesterday’s example, it is $9.77 [$8.80 bid price for call + $0.97 bid price for put]. That’s 30.0% of the stock price. It’s the maximum profit you can generate.
The next thing to determine is the breakeven price at expiration.
On the upside it is $34.77 [$25 strike price + $9.77 net credit] and $15.23 [$25 - $9.77] on the downside. Based on yesterday’s closing price of $32.61, you’re 6.6% from the upside breakeven of $34.77 and 53.3% from the downside breakeven of $15.23.
While anything’s possible, I don’t think its shares will fall to $15.03, to make money on the downside. It hasn’t traded below $15 since November 2023. On the other hand, in this market, it’s hard to see any stock gaining much over the next three months.
Now, in this scenario, and given Toast’s unlikely to fall to $15 in the next three months, the upside is what you have to worry about.
For example, let’s say that the Trump administration says that all tariffs are off, and Canada, Mexico, and the U.S. are going to begin negotiations on a new free trade agreement to replace the one signed in 2018, a year before they’re required to.
Boom. Toast stock jumps 10% or more and never looks back.
In that situation, let’s assume it jumps to $40 by the June 20 expiration. You’re out $5.23 [$40 share price at expiration - $34.77 breakeven], an annualized return of -59% [$5.23 / $32.61 share price * 365 / 99].
I’d go with the short straddle if you're an aggressive investor because it provides income.
Further, the net debit on the long straddle is $9.97, so Toast’s share price could unexpectedly rise to $44.74 [$9.97 - $5.23 + $40] before you’re out more on the short straddle than the long.
