Trader looks for iconic soda maker to go flat as beverage taxes approach

Someone likely thinks conditions may go from bad to worse in the soda business.

News reports this week indicated that soft-drink sales are down 30-40 percent in Philadelphia after the city imposed a tax on sweetened beverages. Attention next shifts to the Chicago region, where a similar measure will take effect in July.1 The developments come at a tough moment for a product category in steady decline since the late 1990s.2

Yesterday a trader likely bet the difficulties will continue for Coca-Cola (NYSE: KO), which has consistently lagged rivals like PepsiCo (NYSE: PEP) and Dr Pepper Snapple (NYSE: DPS). He or she sold 13,300 June 42 calls for $1.02 and bought an equal number of April 42 calls for $0.60. Known as a calendar spread, the strategy yielded a net credit of $0.42.

Calls are options to buy a security, but when they’re sold they create an obligation to deliver shares at a specific price. Yesterday’s transaction reflects a belief that KO will remain at or below $42 for the next 3-1/2 months, in which case the trader keeps the $0.42. (Adjusted for the transaction size, this translates into $558,600, or $0.42 x 100 x 13,300.) A rally much above $42 could hand them significant losses.

That level has marked the top of KO’s range since November, which could lead some technical analysts to think it will remain as the stock’s resistance (a price level chartists view as a tough-to-break through ceiling). The stock closed near it yesterday, down 0.45 percent to $41.99.

KO vs PEP, 5yr chart

Source: OptionsHouse by E*TRADE

Philadelphia’s tax consisted of 1.5 cents per ounce of sweetened beverage, adding more than $1 to the cost of a 2-liter bottle. Cook County, Illinois, which encompasses Chicago and many of its suburbs, will begin charging 1 cent per ounce, starting less than a week before the Fourth of July holiday -- a key time for beverage sales.3

Observers note that KO has tried to cope with consumption declines by growing overseas, refranchising its bottlers and raising prices. Sales and guidance have nonetheless disappointed, and the stock gapped lower after three of its last four quarterly reports. Its next set of numbers are due April 19.

Tuesday’s trade may have also been the work of an investor rolling a short position in the April calls forward by two months. (That would also indicate they see a top at $42.) The transaction pushed overall option volume in KO to over six times the average amount in the last month.

1. Chicago in spotlight next as Philadelphia tax hits soda sales hard. 3/7/17

2. Business Insider: The epic collapse of American soda consumption in one chart. 3/10/16

3. Chicago Tonight: Cook County Approves Soda Tax. 11/10/16