Lamb Weston’s Unusual Options Activity Suggests the Big Fish Are Hungry for French Fries

In Thursday's unusual options activity for calls expiring in seven days or more, Lamb Weston Holdings (LW) had the highest Vol/OI ratio at 258.65, more than double the second-place stock, Microsoft (MSFT), at 103.26. 

The most amazing thing about Lamb Weston’s unusual options activity is how few trades there were for 25,865 call contracts. The other interesting thing about the top call from yesterday’s trading is that it was way, way in the money at 58.17%.

I’m still a relative newbie to options, so this one really captivates my attention. Lamb Weston has not had a good year in the markets. From its June 23, 2023, high of $116.00 to its July 25, 2024, low of $56.53, it’s down 51%.

What motivates the buyers and sellers of the Dec. 20 $32.50 call? I’ll examine both sides of the argument. 

Have an excellent weekend. And don’t forget to vote!

The Interest in Lamb Weston

The potato producers’ total options volume on Thursday was 62,444, with the December 20 $32.50 call accounting for 41% of the daily volume, its largest since April. 

We know that LW stock jumped 10% higher on Oct. 18 due to the news activist investor Jana Partners taking a 5% stake in the food company. Jana would like to see the company put itself up for sale. Working with private investor Michel Fribourg of Continental Grain, they have 10 topics they’d like to discuss with Lamb Weston’s management and board.  

The second of 10 items stands out for me:

“(2) financial performance and core operating deficiencies in areas including customer demand planning and retention, raw potato procurement, ERP system implementation and management, product and manufacturing quality assurance, pricing strategy, retail execution and overhead cost management,” states its 13D. 

Although it doesn't explicitly ask for a sale, one of the 10 items in the 13D requests a strategic review of all the alternatives available to the business to deliver shareholder value, which is generally code for putting the business up for sale.

Jana is one of the more successful activist investors, so investors see a big payday ahead should it be able to get its way with Lamb Weston. 

Five of the nine analysts covering LW stock rate it a Strong Buy (4.11 out of 5). Based on the analyst EPS estimate of $4.26 in fiscal 2025 (May year-end) and $4.97 in 2026, it trades at a reasonable 15.6x the 2026 estimate. 

As one of the world’s leading producers of potatoes and potato-based products, I can see why Jana Partners is interested in righting the business.  

Why Use Deep In the Money Calls?

The chart above is the sales information from yesterday’s trading for the Dec. 20 $32.50 call. The trade prices were between $44.60 and $45.61, considerably less than the ask prices between $46.90 and $47.10.

Based on an average trade price of $45.11, the buyers secured the right to buy 100 shares for 58% of the cost, using leverage and time to their advantage. It’s hard to know if these were Jana Partners trades, but it wouldn’t be surprising if they were.

I’m still trying to wrap my head around using such a significant down payment to secure the right to buy 100 shares. 

However, the advantage of using deep-in-the-money calls is that the price of the option moves up almost dollar for dollar with the share price. The call’s delta is 0.97621. 

Based on the $7,769 ($77.69 share price ), once you deduct $4,511 for the cost of the call contract and $3,250 for the cost of 100 shares at the strike price, you’re left with an $8 profit. If the share price jumps $1, you gain another $98 in profits should you sell the call before it expires in December, and so on. 

What’s the Downside?

Buying deep-in-the-money options is a double-edged sword. For every dollar the share price falls, you lose $98 ($0.98 x 100). So, for example, let's say its share price falls back to $71, where it traded before the announcement of Jana’s stake on Oct. 18. That’s a $6.69 a share decline, moving from an $8 profit to a $661 loss. 

However, on the plus side, if you’re Jana and believe it can revisit $100, where it last traded in March, you’ll take the temporary loss to make the long-term gain.  

The Bottom Line on LW’s DITM Call

Based on S&P Global Market Intelligence data, Jana Partners is the fourth largest shareholder in Lamb Weston.  I’m sure Vanguard, Fidelity, and BlackRock, who own 11.95%, 9.87%, and 7.09%, respectively, would agree to discussions between the company and Jana. 

It’s quite possible that Lamb Weston’s two biggest competitors—McCain Foods and JR Simplot—could take it private, given its depressed valuation. It would cost them less to acquire the company’s lucrative relationship with McDonald’s (MCD).

While it’s doubtful that an acquisition would happen by Dec. 20, Jana and other big buyers of the calls could roll them over before their expiry, into a similar strike price and duration. 

Further, Continental Grain's considerable experience in ag-business M&A should motivate management to improve the company’s performance and boost its share price. 

I’d say a sale is better than 50/50 at this point. It’s an intelligent play. 

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On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.