Typically, the options market gets active during the season as traders posture for positions ahead of earnings announcements, and this season is no different.
The increase in activity offers a great opportunity to gauge investor expectations for earnings. For example, an increase in put activity often tells us that options traders are hedging themselves ahead of an earnings announcement — a sign they are expecting a less-than-bullish result. Conversely, a spike in call volume often suggests that traders’ expectations for earnings are high.
As always, we look at this information with the knowledge that “the crowd” is most often wrong in situations like this, meaning it makes sense to trade a stock with low expectations. Put simply, it is easier for a stock with low expectations to impress the market, and thus move higher. Kind of like a child that brings home a “B” on a grade card when you’re expecting a “D.”
The table below identifies stocks that have seen unusually high put/call ratios, many of which are heading into earnings announcements:
Let’s look at a couple stocks that have gotten earnings out of the way, as well as one that will report far down the road:
Netflix (NASDAQ:NFLX) wowed the Street on Wednesday by announcing a profit when the analysts’ expectations were for a loss. The stock opened nearly 40% higher today as investors jumped all over the earnings surprise.
But believe it or not, there might be even more upside for the streaming video giant.
Ahead of the earnings announcement, there was a surge in put volume, suggesting that options traders were expecting a crash. More importantly, NFLX is the fifth-worstrecommended stock in the Nasdaq-100 Index, with only 17% of the analysts tracking NFLX ranking it a “buy.” This will change in the wake of Netflix’s spectacular earnings, which means we should expect to see upgrades — and that will drive prices even higher.
United Rentals‘ (NYSE:URI) earnings were less impressive — the company did beat EPS estimates by 26 cents, but missed on revenue. At the same time, the company guided FY13 revs below consensus … so why are we interested?
URI has been in a strong uptrend, outpacing the S&P 500 with a return of 26% during the past three months. Given this, we’ll see some profit-taking on the earnings disappointment, but the fact the options market saw a surge of put volume ahead of the report tells us that investors might already have priced some disappointment into shares. This means a pullback in URI is likely to be short — and reasonable.
On a side note, short interest was very high (eight times the average daily volume), also suggesting URI was far from being priced for perfection. Buy this relative strength performer on the upcoming dip!
After lagging the market in the fourth quarter, Nike (NYSE:NKE) is starting to head higher. Options traders appear to be betting against a continuation in the rally, though, as puts on the stock are getting active. As of this week, the average trading day is seeing put volume outweighing calls by almost a 2:1 ratio. We love this pessimistic sentiment as a sign that the “wall of worry” is in place on NKE shares.
Similarly, analyst recommendations on the stock only see 35% “buys,” telling us that there is plenty of room for upgrades to move NKE higher.
Keep an eye on NKE’s 50-day trendline, which just formed a “golden cross” pattern by crossing above the stock’s 200-day trendline. This is where the stock should find support over the next three to six months.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.