Internet stocks are off and running this week, and Adobe Systems (ADBE) is right in the thick of things. Earnings are due after the close of trading tomorrow, and Adobe stock holders will be keen to see if the old-school enterprise software developer finally has its head in the clouds.
Wall Street is anticipating a first-quarter profit of 25 cents per share, down from 35 cents a year ago. But subscriptions will likely be the deciding factor in a rally for Adobe stock. ADBE has said it is on track to surpass its target of 4 million cloud subscribers by the end of 2015. Any deviations in this metric could have a major impact on shares.
Digging into Adobe’s sentiment backdrop, you won’t find many detractors. The analyst community could be expecting big things tomorrow afternoon, with EarningsWhisper.com reporting that the whisper number for Adobe earnings arrives at 27 cents per share — 2 cents better than the consensus.
Elsewhere, 15 of the 25 analysts following Adobe stock rate it a “buy” or better, compared to 8 “holds” and no “sell” ratings. That said, there is room for improvement within the brokerage bunch. The current consensus 12-month price target rests at a meager $65.50, representing a significant discount to the ADBE’s current trading range near $69. Any price-target increases should have a buoying effect on Adobe stock.
Options activity has been the real story today, however, with calls (or bets that ADBE stock will rise) taking center stage. Currently, ADBE sports nearly 52,000 calls in the March/April series of options, compared to put open interest of about 47,560 contracts. The result is a put/call open interest ratio of 0.91.
While this ratio may seem high, with calls and puts nearly in parity, it is at its lowest point of the year, down sharply from its late January high near 2.01. Additionally, call activity has been quite brisk during the past couple of weeks, with ADBE’s March/April put/call open interest ratio plunging from a reading of 1.34 on March 4.
Putting this activity in layman’s terms, options traders appear to be placing significant bets on a near-term rally for Adobe stock. Just how high does options activity hint at for ADBE? Peak call open interest currently totals 8,830 contracts at the 72.50 strike, with another 8,110 contracts at the 77.50 strike. That’s a 5% ($72.50) or a 12% ($77.50) rally for Adobe stock through the end of this week, since March options expire this Saturday.
On the put side, peak open interest resides at the March 65 strike, totaling 20,371 contracts. If these contracts were bought, Adobe stock would need to fall more than 6% for these puts to realize a profit.
Click to Enlarge Overall, March implieds are pricing in a potential post-earnings move of about 5.5% for ADBE. This places the upper bound near $73.86, while the lower bound lies at $66.14. Judging from Adobe’s March open interest configuration, it would appear that there are two prevailing options trading strategies heading into tomorrow’s quarterly report.
2 Options Trades on Adobe Stock
Strategy No. 1 banks on a continued bull run for Adobe stock, targeting a March 72.50/77.50 bull call spread. This aggressive spread expires this Saturday, and, as such, is a pure earnings play on ADBE. The spread was last asked at 57 cents, or $57 per pair of contracts. Breakeven lies at $73.07, while a maximum profit of $4.43, or $443 per pair of contracts, is possible if ADBE closes at or above $77.50 when March options expire.
Strategy No. 2 plays off technical support for Adobe stock in the $65 region, targeting a March 65 put sell position. The March 65 put was last bid at 48 cents, or $48 per contract. The upside to this put sell strategy is that you keep the premium as long as ADBE closes above $65 when March options expire. The downside is that should Adobe stock trade below $65 ahead of March options expiration, you could be assigned 100 shares for each March 65 put sold at a cost of $65 per share. While this outcome might not seem likely, it is always best to be aware of the potential risks ahead of time.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.