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Trade Alcoa Options Bullishly Ahead of Earnings

AA stock is in the midst of a roaring rebound, and the backdrop favors more positive motion after Tuesday's earnings report


Aluminum giant Alcoa (AA) is set to kick off the unofficial start to the second-quarter earnings season after the close of trading Tuesday night. While no longer a member of the Dow Jones Industrial Average, Alcoa’s earnings still carry significant weight on Wall Street, making tomorrow’s report an excellent trading opportunity for savvy investors.

For the record, Alcoa is expected to post a profit of 12 cents per share, up from 7 cents per share in the same quarter last year. Revenue, meanwhile, is seen falling roughly 4% to $5.61 billion year over year.

Long-time Alcoa investors will note that the company is in the midst of transitioning to a manufacturing company, in pursuit of higher margins, and away from a provider of raw materials. Another key part of this transition fell into place last week when Alcoa announced the acquisition of Firth Rixson for $2.85 billion. Look for any new information or guidance on this front to significantly affect AA stock.

Investor and analyst sentiment heading into Alcoa earnings is a mixed bag. Currently, the whisper number arrives at 14 cents per share, 2 cents better than the consensus, hinting at some level of optimism ahead of tomorrow’s report.

However, analysts have been slow to jump on the bullish bandwagon, with Thomson/First Call reporting that 12 of the 18 brokerage firms following AA stock rating it a “hold” or worse. Additionally, the 12-month price target of $15 rests just 2 cents above Friday’s close at $14.98. Given AA stock’s strong price action this year, upgrades or price-target increases from this bunch could provide additional lift for the shares.

alcoa aa stock chart
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Speaking of price action, AA stock has been impressive this year, rallying roughly 40% since the start of 2014. The shares have enjoyed strong support from their 10-day and 20-day moving averages, with the 50-day following the trend higher as a backstop. Currently, AA is consolidating into the $15 region as traders await tomorrow’s quarterly report.

On the options front, there is a split between weekly traders and monthly traders. Specifically, the weekly July 11 put/call open interest ratio currently rests at a very bearish reading of 1.73, with puts nearly doubling calls among short-term options.

With two more trading sessions until AA earnings, look for activity here to ramp up significantly.

Turning to standard monthly options, the July put/call open interest ratio of 0.62 is a complete 180 from its weekly counterpart, with calls nearly doubling puts. This sentiment carries over into the August series of options as well, with the ratio there holding at 0.63. The most popular contracts by far are the July 15 strike, with 16,922 puts and 20,599 calls in residence at this front-month strike.

Traders looking to position themselves ahead of tomorrow’s AA earnings report should know that July weekly implieds are pricing in a potential post-earnings move of about 4%. This places the lower bound near $14.40, while the upper bound lies at $15.60.

Options Trade on AA Stock

With plenty of room for movement among brokerage firms, and Alcoa banking on a red-hot aerospace market, the backdrop seems to favor a bullish stance on AA stock ahead of earnings. As such, an Aug $15/$17 bull call spread has a good chance of hitting its maximum profit potential.

At last check, this spread was offered at 47 cents, or $47 per pair of contracts. Breakeven for this bull call spread lies at $15.47, while a maximum profit of $1.53, or $153 per pair of contracts, is possible if AA stock closes at or above $17 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,

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