Buy Call Spreads Before Yahoo Earnings

by Joseph Hargett | October 15, 2013 9:30 am

Buy Call Spreads Before Yahoo Earnings

Web portal and online content provider Yahoo (YHOO[1]) is slated to slip into the earnings confessional after the close of trading this afternoon, and expectations appear to be a bit elevated ahead of the report. For the record, Q3 Yahoo earnings are expected to fall 6% to 33 cents per share on revenue of $1.08 billion.

With earnings and revenue continuing to slip, investors will be particularly sensitive to any Yahoo earnings details related to improving user metrics or mobile traffic data. YHOO has attempted to make strides on this front via acquisition, snapping up data analysis firm Ztelic, e-commerce application developer Lexity, social browser developer RockMelt, and image-recognition firm IQ Engines during the past quarter.

Yahoo’s acquisitions, its charismatic CEO Marissa Mayer, and its stake in Chinese search engine Alibaba have all helped bolster bullish sentiment toward Yahoo. According to EarningsWhisper.com, the third-quarter whisper number for Yahoo earnings arrives at 37 cents per share, 4 cents better than the consensus.

There still is room for additional bulls on the bandwagon, however.

According to data from Thomson/First Call, analysts have doled out 13 “buys,” 19 “holds” and 1 “sell” rating on YHOO. Additionally, the consensus 12-month price target of $31.42 represents a nearly 8% discount to Monday’s close at $34.10.

With that in mind, options traders are clearly looking for additional upside for YHOO. In the front two months of options, YHOO call open interest totals 379,550 contracts, compared to put open interest of just 181,410 contracts. As a result, the October/November put/call open interest ratio has fallen to a reading of 0.48, with near-term calls more than doubling puts.

That said, even the enthusiasm from bullish options traders is a bit muted. For instance, peak October call open interest of 44,838 contracts lies at the deep in-the-money 29 strike. In fact, the next two most populous call strikes in the October/November series of options (the Oct 31 strike, with 37,396 contracts, and the Oct 30 strike, with 35,466 contracts) are well in the money. In other words, even options bulls appear to be playing it safe.

Taking a look at the put side, YHOO bears have targeted the out-of-the-money Oct 30 and 29 puts, with roughly 19,000 contracts residing at each strike. Other notable put strikes include the deep out-of- the-money Oct 25 strike, with 17,055 contracts, and the Oct 26 strike, with 15,915 contracts.

Overall, YHOO October implieds are pricing in a potential post-Yahoo earnings move of about 5.7%. This places the upper bound at $35.95, while the lower bound resides at $32.05. These bounds fall nicely in line with YHOO’s current technical backdrop.

YHOOchart 300x247 Buy Call Spreads Before Yahoo Earnings
Click to Enlarge
Overhead resistance currently rests at 35, with the shares being soundly rejected at this level during the first week of October.

Technical support, meanwhile, materializes in the $29-$30 region. This area is home to round-number support, YHOO’s rising 50-day moving average, and also was the site of former resistance back in mid-July.

For those looking to trade YHOO options ahead of tonight’s Yahoo earnings report, the stock’s improving sentiment and technical backdrops bode well for a potential post-earnings rally.

Following what appears to be cautious smart money in the options pits, traders might want to consider a Nov 34/36 bull call spread ahead of Yahoo earnings.

At the close of trading on Monday, this spread was offered at 76 cents, or $76 per pair of contracts. Breakeven for this trade lies at $34.76, while a maximum profit of $1.24, or $124 per pair of contracts, is possible if YHOO closes at or above $36 when November options expire.

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

Endnotes:
  1. YHOO: http://studio-5.financialcontent.com/investplace/quote?Symbol=YHOO

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