Why McDonald’s (MCD) Stock Options May Be Offering Value-Meal Pricing

With inflation imposing a very real concern across the economy, it’s difficult to find value — even from traditional value leaders like fast-food giant McDonald’s (MCD). However, for aggressive bullish speculators, MCD stock could be due for a possible comeback. In addition, one of the call option spreads may be underpriced relative to the historical risk that traders are expected to incur.

Mechanically, I’m working with two presuppositions. First, I operate under the framework that the future market returns for MCD stock represent dependent variables. Basically, this concept means that the future outcome of McDonald’s market value depends heavily on its immediate circumstances. Second, I believe that order flow imbalances trigger responses that cannot readily be explained as random.

As such, I’m not an efficient market, random walk guy. Instead, I believe that because market returns aren’t random but are impacted by specific conditions, if we can quantify what those conditions are, we can estimate — through inductive analysis — where McDonald’s stock is likely to end up over a given period of time.

It must be stated upfront that I don’t have a crystal ball. As with every other analysis, mine will involve probabilities, not certainties. Where I’m going to differ with my colleagues is that I’m going to show you the odds that Wall Street assigns — and why I think those odds are mispriced.

Specifically, I’m interested in the 272.50/277.50 bull call spread expiring Aug. 21. This trade requires McDonald’s stock to rise through the $277.50 strike at expiration to trigger the maximum payout of almost 113%. However, what’s really interesting is the breakeven price of $274.85.

Wall Street assigns a probability of profit of only 41.6% that this threshold will be triggered at expiration. I think the market is overstating the risk based on the quantitative structure of MCD stock; hence, my near-term bullishness toward the fast-food giant.

Earnings Could Offer a Catalyst for MCD Stock But It’s an Unknown

Before justifying the aforementioned bull spread, you should be aware that the smart money currently isn’t all that convinced about McDonald’s stock. If you look at the volatility skew for the Aug. 7 expiration date — keeping in mind that McDonald’s is set to release its earnings report on Aug. 4 — the volatility surface shows a classic, symmetrical “smile.”

Instead of market participants heavily leaning into one side, MCD options traders are bidding up implied volatility on both wings. Effectively, the smart money is buying insurance against two potential outcomes: a strong move higher (upside risk) or a continuation of the security’s corrective cycle (downside risk).

Arguments for both sides exist, with Barchart’s Will Ashworth detailing the key bullish factors that could potentially bolster MCD stock. But there’s also the broader economic challenges that have to be taken into account. It’s hardly surprising, then, that a smile appeared in the Aug. 7 volatility skew.

Of course, this positioning of options trades isn’t set in stone. Because no one knows for sure what kind of results McDonald’s will deliver — or how MCD stock will respond to this specific catalyst — we could see a completely different skew in the days ahead. But in the spirit of full disclosure, you should be aware of the smart money’s hedging.

Order Flow Imbalance May Favor McDonald’s Stock

On a year-to-date basis, MCD stock has suffered a decline of more than 11%. Subsequently, the ticker has ignominiously earned the label of 100% Strong Sell by the Barchart Technical Opinion indicator. That’s another reason to enter the bullish trade with eyes wide open. At the same time, I think a turnaround is plausible.

As I said earlier, I frame market returns as dependent variables. Because McDonald’s stock is currently stuck in a bearish cycle, how the rest of the market responds to MCD will differ had the cycle been bullish or consolidatory. Moving forward, if we know how MCD moves under specific circumstances or conditions, we may be able to estimate where it goes next based on past precedent.

For example, we know that in the last 10 weeks, MCD stock printed four up weeks, thus leading to a downward slope (due to the higher balance of negative sessions). This 4-6-D quantitative sequence has flashed 50 times since January 2019. What’s more, under this state, McDonald’s typically sees an above-average performance relative to the random baseline.

Following the flashing of the above signal, MCD stock over the next 10 weeks would be expected to range between $264 and $293 (assuming a starting point of $270.67). That’s a much more favorable distribution than if a trader randomly held MCD without regard to timing or structure. In this case, the expected distribution would only be between $269 and $279.

Interestingly, on week 4 following the flashing of the 4-6-D signal, McDonald’s stock has historically risen about 2.34% as a median expected performance. If so, that would put MCD quite close to the second-leg strike of the 272.50/277.50 bull call spread expiring Aug. 21.

Exploiting the Potentially Underpriced Options Spread

Earlier, I made the comment that the above bull spread is mispriced. At time of writing, the market has assigned a probability of profit of 41.6% that MCD stock can hit the breakeven price of $274.85 at expiration. However, this calculation stems from a Black-Scholes-derived framework, which assumes that future market returns are independent variables.

To the formula, it doesn’t structurally matter that McDonald’s stock incurred an extended downturn. Instead, the outputted probability stems from the implied volatility figure at the point of analysis and is run through a defined model. In other words, the model will spit out a probability per pre-defined parameters.

In contrast, I’m viewing McDonald’s from the lens of variable dependency. In other words, it matters that MCD stock incurred an extended downturn because this fact has statistically altered the forward trajectory of the ticker beyond what is expected from a random hold.

Specifically, we know that of the 50 times that the 4-6-D signal has flashed, MCD stock has risen above the $274.85 breakeven price a total of 27 times at the end of week 4. From an observational, conditional standpoint, the probability of profit of the 272.50/277.50 bull spread could be 54%, not 41.6%. Assuming the viability of the variable-dependent model, there is a mathematical incentive to consider a near-term bullish position on McDonald’s.