Chancing It With IBM? Try This Trade

The pre-earnings picture isn't pretty, but there are some high-risk/high-reward options opportunities if you're game

   

Blue-chip IT firm International Business Machines (IBM) finds itself in a must-win situation heading into tonight’s second-quarter earnings report. Despite a history of long-term growth, IBM recently has struggled to keep pace over the short-term with more nimble competitors offering trendy, low-cost cloud-based IT services. The company’s inability to close key deals dented its bottom line in Q1, and investors will be keen to see if IBM has overcome these hurdles in the second quarter.

In the first quarter, IBM reported a 5% decline in revenue and missed earnings expectations by 5 cents per share. After the close, Wall Street is looking for earnings to rise 7% to $3.77 per share, on average, on revenue of $25.39 billion. Gross margins — a key metric for many IBM investors (especially institutional investors) — are seen coming in at 48.9%.

Outside the numbers, Wall Street will be looking for updates on pending deals with its Middleware and Server divisions — the same deals that impacted IBM’s Q1 revenue. Also, the company instituted a “workforce rebalancing” program at the beginning of Q2, and any updates on this could impact the company’s forward-looking statements.

Speaking of forward-looking, Wall Street also is expecting an update on IBM’s full-year fiscal 2013 earnings outlook. Back in April, the company said it expected to earn at least $16.70 per share on the year. Since then, the consensus estimate has slipped to a forecast for $16.63 in EPS.

Taking a closer look at Wall Street’s expectations for IBM, we find that analysts are cautiously optimistic. According to EarningsWhisper.com, the whisper number on the Street for IBM’s second-quarter earnings comes in at $3.81 per share — 4 cents higher than the consensus.

Meanwhile, the brokerage community has doled out 11 “buy” ratings, versus 14 “hold” or worse ratings. Additionally, the consensus 12-month price target of $220 represents a modest premium of 13% to IBM’s close at $193.85 on Tuesday. In layman’s terms, there is room for improvement in IBM’s ratings and price target, but the company might have a hard time reassuring these fence-sitters.

The sentiment situation is similar over in the options pits. In the front two months of options, IBM has accumulated call open interest of nearly 90,000 contracts, compared to put open interest of roughly 80,000 contracts. The resulting July-August put/call open interest ratio of 0.88 offers a pretty neutral sentiment reading, though I would expect to see a bit more call activity heading into an earnings release.

On the call side, the majority of open interest is centered at the out-of-the-money July $195, $200 and $205 strikes, which sport roughly 13,000 contracts each. Put activity, meanwhile, is focused at the July $190 and $195 strikes, totaling about 12,000 contracts each. As of the close last night, IBM was pinned between the $190 and $195 strikes.

Overall, options traders are pricing in a post-earnings move of about 5.5% following tonight’s Q2 earnings release. As a result, the upper bound of IBM’s expected move rests at $204.60, while the lower bound arrives at $183.10.

IBMdailyearnings 300x247 Chancing It With IBM? Try This Trade
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These levels correspond with key technical levels for IBM. Specifically, the $200-$205 region is home to psychological resistance at $200, IBM’s 50-day moving average at $200.93, and chart congestion at $205. On the downside, $185 appears to be immediate technical support, while $183 (the aforementioned lower bound) is just below IBM’s July and December 2012 lows.

The picture clearly isn’t pretty, with mixed investor and analyst sentiment, a poor technical backdrop, and seemingly elevated Q2 earnings expectations. All in all, options traders might want to hold off on taking a position on IBM ahead of tonight’s event.

However, if you are an IBM optimist — or just looking for a high-risk/reward trade — an August 190/205 bull call spread could be right up your alley. The August 190/205 bull call spread takes advantage of IBM’s potential volatility while betting on the company righting some of its first-quarter wrongs.

After the close of trading last night, this spread was offered at $6.11, or $611 per pair of contracts. Breakeven lies at 196.11 — a 1.17% advance from yesterday’s close — while a maximum profit of $3.89 is possible if IBM closes at or above $205 when August options expire.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/07/chancing-it-with-ibm-try-this-trade/.

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