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How Goldman made 65% on Chipotle

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Chipotle shares have been decimated by the company's problems with E. coli and norovirus. But the bad news for lovers of burrito bowls and hot stocks has been good news for those who followed an options strategy suggested by Goldman Sachs.

In a Dec. 2 note, Goldman's options strategy team suggested buying both bullish and bearish options on Chipotle in order to take advantage of uncertainty around food-borne illness outbreaks.

Strategists Katherine Fogertey and John Marshall wrote that they expected Chipotle to "update investors as to the financial impact" of the E. coli outbreak. Despite the high potential for market-moving news, options pricing "does not reflect the higher uncertainty we see in the coming weeks." In fact, the options market was actually pricing in less volatility than it typically does ahead of earnings.

The strategists consequently recommended buying both a call and a put expiring on Friday to capitalize on the potential for a big move higher or lower.

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Happily for those who put on the trade, Chipotle management indeed updated guidance last Friday, saying it expects sales at established locations to fall 8 to 11 percent in the current quarter.

That sent the stock sharply lower, and when the shares hit $343.75, Goldman recommended closing out the trade for $39. Since the options had cost $23.70 when the stock was trading at $580.74, that means the trade was good for a 65 percent gain.

Needless to say, not every trade recommended by Goldman's options team is a winning one. But options experts are lauding the thinking behind this trade.

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"This was an excellent call," said Dennis Davitt, chief investment officer of Harvest Volatility Advisors. "As an old options trader, we used to say, when vol [meaning implied volatility] was cheap, when options were cheap, we would buy them; when they got expensive, we would sell them; and then when they got really, really expensive, we would buy them all back and go long options, because there's clearly something in the marketplace."

Technical analyst Todd Gordon of points out that the Fogertey and Marshall "were not trading the chart of CMG per se; they were trading the chart of volatility. … Goldman simply went long volatility on a pullback."

"Often we're critical of Goldman's options trades, but this was well crafted," Gordon said.

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