Spread Out to Play a Continued Yahoo Comeback

by Joseph Hargett | July 16, 2013 9:02 am

Is Marissa Mayer’s turnaround plan for Yahoo (YHOO[1]) yielding results? That’s the question YHOO shareholders are asking, and the question Yahoo will answer this afternoon when the company releases its second-quarter earnings report.

However, while most of Wall Street seems to be on the fence about the verdict, option traders apparently have already made up their minds.

Since Mayer took over the helm roughly a year ago, the changes at Yahoo have been noteworthy, though perhaps not as dramatic as many would have hoped. Still, Mayer has helped to not only stabilize Yahoo’s revenue situation, but actually delivered signs of growth. Nonetheless, the former Google (GOOG[2]) executive has urged investors to be patient, stating that her turnaround plan will take several years to fully take hold.

Looking ahead to tonight’s report, analysts are expecting second-quarter earnings of 30 cents per share, up 11% over the same period last year. Revenue, meanwhile, is seen coming in flat at $1.08 billion.

Earnings estimates include additional income from Yahoo’s remaining 24% stake in Chinese Internet firm Alibaba — Yahoo received $7.6 billion for roughly half its stake[3] in a deal brokered last year. Looking ahead, analysts at Macquarie Capital estimate that selling its remaining stake in Alibaba could bring in another $20 billion[4] over the next few years.

Sentiment is mixed on Wall Street ahead of tonight’s report.

On one hand, Yahoo’s Q2 earnings whisper number comes in 5 cents higher than the consensus at 35 cents per share, according to EaringsWhisper.com.

On the other hand, these same analysts have doled out 19 “hold” or worse ratings, compared to just 13 “buys.” Additionally, the 12-month consensus price target for YHOO rests at $29 — a premium of only about 6% to Monday’s close. These lowered expectations could be a boon for Yahoo if the company has any bullish surprises this afternoon.

Turning to options activity, traders are heavily favoring calls ahead of tonight’s report. Some 205,000 calls are open in the July and August series of options, compared to put open interest of roughly 141,000 contracts. The result is a front-two-month put/call open interest ratio of 0.69 — a reading with a reasonably bullish slant.

Drilling down on this activity reveals that peak call open interest totals 20,655 contracts at the July 26 strike, followed closely by 18,628 contracts and 16,184 contracts at the July 25 and 24 strikes, respectively. Note that all of this call open interest is firmly in-the-money, meaning that despite being bullish, options traders are playing their optimism close to the vest.

On the flip side, peak put open interest resides at the deep out-of-the-money July 17 and 19 strikes, totaling 20,432 contracts and 20,361 contracts, respectively. A little closer to home, there are 15,315 puts at the July 25 strike and 16,657 puts at the July 24 strike. Unlike call traders, put traders have placed bets well out of the money ahead of Yahoo’s quarterly report, indicating a distinct lack of confidence in the company.

Historically, YHOO shares have moved an average of about 3% in the wake of the company’s quarterly report. This time around, July option implieds are pricing in a post-earnings move of about 3.7%. This places the upper bound of a post-earnings move near $28.52, with a lower bound near $26.48.

Click to Enlarge Technically speaking, YHOO faces resistance at its mid-May peak near $27.50. Meanwhile, first support emerges near $27, while a more solid floor can be found at $26, where YHOO’s 10-day, 20- and 50-day moving averages are converging.

Also of note, YHOO’s 10- and 50-day trendlines are on the cusp of completing a bullish cross — a technical formation that often signals short-term upside for shares.

With a strong technical backdrop and improving financials, Yahoo stands a good chance of extending its rally following a positive second-quarter report. What’s more, this rally could receive a boost in the form of upgrades or price-target increases from the laggards in the brokerage community.

As such, those options traders looking to get in on YHOO ahead of the event might want to consider a bull call spread.

Along those lines, an August 27/28 bull call spread stands a good chance of not only realizing a profit, but potentially hitting a double. At the close on Monday, this spread was offered at 49 cents, or $49 per pair of contracts, placing breakeven at $27.49 — a gain of only about 0.5% from yesterday’s close.

A maximum profit of 51 cents, or $51 per pair of contracts, is possible if YHOO closes at or above $28 when August options expire, while the maximum loss on this position is limited to the initial capital outlay.

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

Source URL: https://investorplace.com/2013/07/spread-out-to-play-a-continued-yahoo-comeback/

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