YUMC Sell Signal

The lengthy downtrend in Yum China Holdings (YUMC) was interrupted a few times over the summer as traders reacted to various merger-and-acquisition rumors. Reports of interest by Hillhouse Capital propelled the stock off its annual lows in late July, and a mid-August bull gap was sparked by reports that China Investment Corp. and DCP Capital could join the bid. And while YUMC initially rallied on Aug. 28 following news it had rejected the consortium’s $46-per-share offer, the stock has since backpedaled — representing just the latest pullback from stubborn resistance at a trendline with historically bearish implications.

Specifically, Schaeffer’s Senior Quantitative Analyst Rocky White reports that over the last three years, there have been two prior instances of YUMC rising to trade within one standard deviation of its 160-day moving average after having spent the majority of the past two months below it. (For these purposes, that means YUMC has been below its 160-day at least 60% of the time for the past two months, and eight of the last 10 trading days.)

Following those two prior signals, YUMC was trading lower one month later on both occasions, with the average return arriving at a loss of 5.35%. Based on the stock’s current price of $38.45, another drop of this magnitude would place the fast-food name around $36.39 by this time next month.

And with no signs of a bidding war on the horizon for YUMC, there’s plenty of pent-up M&A optimism left to unwind, which could accelerate the stock’s decline from this resistance level. Half of the analysts following this underperforming equity still call it a “buy” or better, leaving plenty of room for downgrades in the weeks ahead.

Plus, options traders are overwhelmingly upbeat. During the past 10 days, speculative players on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) have bought to open 14.82 calls for every put on YUMC. This ratio ranks in the 82nd percentile of its annual range, revealing a stronger-than-usual skew toward bullish bets over bearish in recent weeks.

There’s little room for YUMC to benefit from future short-covering support, either. Following a 47.4% decline in short interest during the past two reporting periods, short interest now accounts for just under 1% of the equity’s float — amounting to very little in the way of sideline cash to fuel future rally attempts.

As YUMC backs down from key resistance on the charts, a significant leg lower could result from the unwinding of this widespread optimism. Traders can capitalize by picking up put options on the stock, which are currently priced cheaply, from a volatility perspective. Schaeffer’s Volatility Index (SVI) for YUMC stands at 41%, in the 26th annual percentile — which means front-month options have priced in lower volatility expectations only about one-quarter of the time over the past year.