DineEquity: Dining On Shorts?

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DineEquity (DIN), the operator of iHop and Applebee’s restaurant chains, reported better-than-expected earnings, and shares jumped some $2 (or over 10%) to a new 9-month high of $29 and are up over 300% from the $6 March low. I think the stock is overextended and ripe for a pullback, and therefore I'm establishing a bearish position by creating a synthetic short. Specifically:
 

• Sold to open 10 May $30 calls (DINEF) at $1.65 a contract
• Buy to open 10 May $25 puts (DINEQE) at $1.35 a contract.

This position is being created for a $0.30 net credit. I wouldn't do it for any worse than even money.

By using the sale of calls to finance the purchase of puts, I’m establishing a no/low-cost bearish position that's close to being synthetically short stock. At current prices with shares of DineEquity at $28.50, the delta is -82 for the above position.

The risk is similar to being short shares, and will become equal to being short 1,000 shares once the stock rises above $30.50. But, since this is post earnings, being short calls shouldn't pose much vega risk. That is, I don't see a scenario in which a rising stock price will also be accompanied by an increase in implied volatility.

That said, I'll use a stop of a close above $31 a share as stop for minimizing losses.

Not All Flap Happy

My thesis for the bearish position is the stock has simply come too far, too fast, without significant improvement to its underlying fundamentals. Admittedly, the business has been the beneficiary -- along with many other low-cost food chains -- of the dual perception that the stock valuation was too low, and that the outlook among consumers was too gloomy. Today’s increase in the consumer confidence seemed to reinforce that view.

But the company took on huge debt to acquire the Applebee’s chain, and was way behind schedule in selling franchises and locations to help pay down that debt. So, while this quarter made progress in addressing those issues, most of the better-than-expected numbers were the result of cost cutting and the sale of assets - which allowed it to securitize and pay down $87 million in debt.

DineEquity is by no means sitting on a strong balance sheet, nor is it seeing significant increases in cash flow. Same-store sales stabilized at basically flat, top-line revenue fell 16% and continued contraction of its growth rate.

Finally, there's heavy short interest, equal to over 18% of the float. And today’s action looks like a bit of squeeze and blow-off top.

A similar situation occurred in Chipotle Mexican Grill (CMG) following its earnings, and its shares, after an initial spike, have seen a big pullback.