Net Credit Spread Trade on TAP’s Terrible Report

A little over two years ago, the global beer market changed radically. While there are more beer companies in the world than at most points in history, the control of that market has never been tighter.

Anheuser-Busch InBev bought up SABMiller for $107 billion. From the original top three players, this merger left only two: InBev and Molson Coors (TAP).

The merger also did something else that reshaped the industry. Instead of a somewhat fair three-way fight between the light beer dominators, now the maker of Coors and Coors Light is trying to fight against a much larger bigger brother.

This morning, we got a clear taste of just how much this new market position is hurting Molson Coors. The company announced its fourth-quarter earnings.

It did beat analysts’ estimates for its bottom line, coming in at $0.84 per share compared to expectations of $0.79 per share. But the rest of the report showed the dire position the global beer company is in.

Revenue at Molson Coors was $2.42 billion in the fourth quarter, below estimates of $2.54 billion, and down 6.2% year over year. Worse, its outlook dropped. And worst, it had to restate its previous two years’ worth of financial reporting due to a mistake in its tax accounting.

The company did note an uptick in pricing on a constant-currency basis. But based on actual volumes and sales per hectoliter, even those numbers declined during the quarter.

The restated tax figuring is a problem that might not go away in a few days either. Already, just hours after it announced the error, a class-action lawsuit is in the works for investors who believe they were misled. You can’t exactly blame them either. The company is down nearly 10% on the day.

This is bleak. But the real underlying problem is what will keep investors away for quite some time… and potentially even send shares of Molson Coors down further from here.

You see, the volume figures from the company’s quarter are the most telling. Worldwide, consumers are choosing wine and spirits over beer. And the boom over the last 15 years in craft and local beers are finally starting to eat into the big three’s (now, the big two’s) sales.

The company, to be fair, did have a somewhat promising year in Europe. But in just about every other geographic segment, people simply bought less of the company’s beer. The U.S. and Canadian segments, where it sells most of its volume, had a terrible period.

All of this adds up to what should be a period of sustained weakness at Molson Coors. In fact, this report and Molson’s outlook are so bad, they’re enough to make people forget the shaming InBev put on the company in that viral Superbowl advertisement featuring the “corn syrup” barrel.

Fortunately, there’s a way to play this near-certain trend without risking much capital. You don’t have to short the company’s stock or place a large bet on InBev or another global competitor. Instead, you can use a simple strategy we’ve discussed here several times.

Let’s get into it…

A Strategy For Short-Term Weakness

A bear call spread is a type of options trade that involves two call contracts. A trader that believes a stock will remain weak for a period of time could initiate a bear call spread trade by selling a call option on that stock with a strike price near the current price of shares and buy a second call option with a higher strike price.

What this does is create a net credit to that trader’s account. Meaning the entire potential reward for it is pocketed right up front. The trader gets to keep that full credit as long as shares of the underlying stock don’t rise above the sold call.

Think about that. This is a trade that wins if shares fall at all. But it can still win if shares just simply don’t move. No straight put option or a short position in stock can offer those odds.

If shares do rise, however, all is not lost. Until they rise past the point of that initial credit, the trader would still make a slight profit. The only time when he would lose is if shares really rally in the duration of the trade.

But unlike a naked call position (which would be the same without the second call option… the one bought with a higher strike price), there’s a cap to potential losses.

Even if shares rise sharply, the trader’s total potential loss is capped. You can see what this kind of trade looks like here:


Source: The Options Industry Council

Let’s dig into a specific trade for this Molson Coors’ situation…

A Specific Trade on TAP

A trader looking to profit off Molson Coors’ bleak outlook and expected rough few months could sell a March 15 $60 call for $1.30 per share and buy a March 15 $62.50 call for $0.45 per share for a net credit of $0.85 per share. Since each represents 100 shares of TAP, that works out to an initial credit to the trader’s account of $85.

That’s his total profit potential. But unlike almost every other type of trade he can make, he keeps the full amount as long as shares don’t do anything. If they fall, he keeps it. If they remain below $60, as they are now, he keeps it.

His potential loss is capped at $165. To find that, take the difference in strike prices between the two call options in this trade ($62.50 – $60 = $2.50), subtract the net credit the trader received ($2.50 – $0.85 = $1.65) and multiply by 100 shares ($1.65 x 100 shares = $165).

Now, if shares rise a little bit, he likely won’t need to dish out that full $165. Shares would have to jump above $60.85 (the sold call’s strike plus the credit) for the trader to take any actual loss on this trade. And it doesn’t look like shares of TAP are likely to move up even a little bit, let alone above that mark.

Molson should remain weak until at least this expiration of March 15. Likely, it’ll stay depressed all year and possibly longer. But we just cannot guarantee it’ll fall any harder than it already has. We just believe it doesn’t rise at all.

This bear call spread is the perfect way to play this judgment. Shares fall from here or remain right where they are… and this trade produces a tidy profit.

— The Option Specialist

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About the Author: The Option Specialist