Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Dunkin's Straddles Are Clearly Mispriced Now

Dunkin' Brands Group, Inc. (DNKN), a franchisor of quick service restaurants (QSRs) serving hot and cold coffee and baked goods, as well as hard serve ice cream, is reporting earnings tomorrow at the market's opening:

(Source: TD Waterhouse)

The company beat earnings estimates in 75% of time on the last eight quarters (underperformed in 12.5% of time and showed in-line numbers in 12.5%, as well) and has shown swift movements in the market price of the stock:

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

On the other hand, market data show that the short-term options are relatively cheap:

(Source: TD Waterhouse)

The straddles (options with a strike price of $47.50) are worth around 6.5% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source:Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 7.5% over the last 52 weeks, while the straddle expiring in a bit less than a month has an implied monthly volatility of around 6.5%, while it also includes volatility from the earnings event tomorrow. I therefore see signs of clear undervaluation in these options.

What do you think of this trade?