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In the 1990s, there was perhaps no cooler place than a local Starbucks.

The company’s longtime CEO Howard Schultz recalled going to Milan, sitting in one of the many coffee shops and having an epiphany. He saw how a simple, mid-afternoon expresso could lift the spirits of a city and thought, Why not bring that to Seattle?

Of course, replicating the tone and tenor of Milan is easier said than done, so Schultz, always the marketing savant, repackaged the experience. Sandstone floors, comfy chairs and Wi-Fi replaced the more romantic Italian grottos, but the effect was still the same: a seven-minute vacation from an urban jungle.

And worked. Brilliantly. Starbucks went form 700 stores in the mid 1990s to 16,000 today.

But bulk isn’t always better, and the rushed pace of mobile ordering changed the Starbucks experience. It no longer felt special. The stores got dirtier. The lines grew longer. Baristas were soon overwhelmed. New CEO Brian Niccol vowed to change that.

So far, it’s working. The in-store experience has improved. Starbucks shares are making strides, up 12% this year, but it’s well off its recent highs and has been dead money over the last five years. Improving execution underneath and a demanding valuation overhead make selling the November 85/105 strangle attractive: collect premium while the turnaround works through a modest growth environment and a fairly ambitious valuation.

Outlook

My own visit to a store in the San Diego area reinforced my recent experiences elsewhere. Employees are trying to be friendlier and more engaging. The experience feels closer to a local business and less like the corporate kiosk McDonald’s has lately become.

Fundamentals

Valuations are keeping a lid on the stock, however. The consensus forward adjusted EPS estimate of ~$3.12 means Starbucks trades around 30 times forward earnings. Enterprise value is 17.6 times forward estimated EBITDA, considerably higher than the industry average of ~12x.

Support comes from potential capital returns. Divesting 60% of China retail operations, which finalized in April, strengthened financial flexibility and potentially creates room for future buybacks alongside a commitment to dividends.

Options trade

From an options perspective, over the past two years implied volatility (the level of options premiums) has averaged well above realized volatility. Put simply, options look expensive relative to how much the underlying stock is moving, making a short premium play attractive. Investors appear to be overpaying for uncertainty.

The trade

• Sell one November $85 put
• Sell one November $105 call
• Net credit: $2.25 credit

If the stock stays were it is, this strategy will yield a 16% annualized return. The big risk is getting short at $107.25, a 13% premium to its current price, or getting long at $82.75, or 12% lower.

Disclosures: Tidal owns/holds all the securities mentioned in the article.

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