by Joseph Hargett | April 19, 2012 7:59 am
The Dow Jones Industrial Average (DJIA) suffered a mild correction last week, but the blue-chip barometer has since shaken off overseas troubles to rally back from support at its 20-week moving average and reclaimed the 13,000 level.
This should be good news for Dow options traders, as it sets a solid technical backdrop just in time for the thick of earnings season. Among those DJIA components joining the earnings parade this week are Microsoft Corp. (NASADQ: MSFT), McDonald’s Corp. (NYSE:MCD) and General Electric Co. (NYSE:GE).
The world’s largest software company is scheduled to slip into the earnings confessional after the close of trading this afternoon. Analysts are expecting Microsoft to post a profit of 58 cents per share, a decline of 5% from the same quarter last year. The whisper number comes in at 60 cents per share. Historically, Microsoft has bested Wall Street’s expectations in two of the prior four reporting periods, with an average upside surprise of nearly 11%.
Speaking of the Street’s outlook, the brokerage community has issued 22 “buys,” 12 “holds,” and just one “sell” rating; a rather bullish outlook for Microsoft. However, there is room for improvement, as the consensus 12-month price target rests at $34 – a premium of only about 9% from Wednesday’s close of $31.14. Any post-earnings price-target increases could be a boon for MSFT.
Options traders, meanwhile, are loading up on puts heading into Microsoft’s quarterly report. Among the front three months of options, roughly 585,000 and about 500,000 puts are currently open, resulting in a put/call open interest ratio of 0.85. According to data from Schaeffer’s Investment Research, this ratio resides above 80% of all those taken in the past year. In laymen’s terms, options traders have rarely been more bearishly aligned toward MSFT in the past year.
While options traders may be tempted to jump on the bearish bandwagon ahead of MSFT’s quarterly report, the overall technical trend may favor call traders. Specifically, MSFT is in the process of rebounding from support at the round-number $30 level, following the rest of the Dow higher.
As such, a May 31 call, which closed Wednesday with an ask price of 81 cents, could be a profitable bet. Traders could also leg into a bull spread and lower their risk by selling a May 33 call. At the close on Wednesday, a May 31/33 bull call spread could have been purchased for 68 cents, placing breakeven at $31.68 – a gain of about 1.6% from yesterday’s close.
Continue reading for two more Dow options plays ...
McDonald’s investors will be watching closely tomorrow morning, when the fast-food giant steps up to deliver its quarterly earnings report. MCD shares are currently underperforming the Dow, with a year-to-date decline of roughly 3.7%, making McDonald’s bulls a little bit uncomfortable. The stock is currently trending lower beneath several major moving averages, but support lies just beneath MCD at the $95 level.
For the record, Wall Street is expecting earnings to rise about 7% to $1.23 per share, while revenue is seen slipping 7% year-over-year. McDonald’s has a steady track record in the earnings limelight, with the company topping the consensus estimate in each of the prior four reporting periods, though the average upside surprise is a mere 2.5%.
Options traders appear to be keying off MCD’s poor price action, with put volume spiking relative to call volume heading into the earnings event. Specifically, put volume swelled to nearly 10,500 contracts on Wednesday, compared to call volume of 8,600. The result is a single-session put/call volume ratio of 1.22. What’s more, put open interest has been growing relative to call open interest among near-term options since April 13.
Instead of considering a bullish or bearish play on MCD, traders may want to consider a volatility play ahead of the company’s quarterly report. According to weekly April options, traders are expecting a move of less than 2% out of MCD shares post earnings. As such, MCD should stay well within the bounds of an April 100/95 short strangle through the close of trading on Friday (when April options expire).
To enter this short strangle, traders would simultaneously sell an April 100 call and an April 95 put, which were bid at 11 cents and 18 cents, respectively, at the close on Wednesday. A maximum profit of 29 cents, or $29 per pair of contracts, is achieved if MCD closes between $95 and $100 on Friday. Please note this is a limited reward/unlimited risk position, and should therefore be left to more experienced options traders.
Last, but not least, blue-chip conglomerate General Electric Co. is expected to post earnings of 33 cents per share ahead of the open tomorrow morning. In the same quarter last year, GE earned 31 cents per share. Historically, the company has bested Wall Street’s estimates in three of the prior four reporting periods by an average of about 5.5%.
GE shares have largely been trapped in a trading range between $18 and $20 since the beginning of 2012, resulting in a paltry year-to-date gain of about 6.6%. According to April options data, GE isn’t expected to stray from this trading range in the wake of tomorrow’s earnings report, with implieds forecasting a post-earnings move of about 2.8%.
Taking a closer look at GE’s options data, it appears that traders are expecting a post-earnings rally. Specifically, the put/call open interest ratio for the front three months arrives at 0.68, a reading that is just one percentage point shy of an annual low, according to Schaeffer’s Investment Research.
Turning toward the weekly April series of options, notable call open interest resides at the overhead 20 and 21 strikes, with more than 115,000 open contracts residing at both strikes. Given GE’s current trading range, it is possible that options traders have opened up bearish call spreads at these strikes. At the close of trading on Wednesday, an April 20/21 bear call spread was bid at four cents.
However, for those traders looking for a more bullish GE earnings play, the May 19/20 bull call spread was asked at 40 cents as of the close of trading on Wednesday. Breakeven for this trade rests at $19.40, while a maximum profit of 60 cents, or $60 per pair of contracts, is realized if GE closes at or above $20 when May options expire.
As of this writing, Joseph Hargett does not own or hold a position any shares mentioned here.
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