It’s safe to say that expectations are pretty low for aluminum producer Alcoa Inc (NYSE:AA) when it kicks off another round of corporate earnings reports after the close of trading tomorrow.
AA stock is down roughly 15.7% year-to-date, and saw a 51% spike in short interest during the most recent reporting period.
While AA is no longer the broad-market bellwether it once was, many on Wall Street will still be paying close attention to its quarterly numbers.
For the record, analysts are expecting Alcoa to post a profit of 26 cents per share — nearly triple its year-ago results of 9 cents per share. Revenue is also expected to rise year-over-year from $5.4 billion to more than $5.9 billion.
On the surface, these numbers look quite impressive, and honestly, they are.
But earnings season is all about expectations. At the beginning of the year, Alcoa set the bar pretty high by forecasting global demand growth of 7%. But aluminum prices have since hit the skids, plunging 7.5% due to weak economic growth and an unusually strong U.S. dollar.
As a result, Alcoa has announced plans to stop smelting at its Brazilian facility this month and has acquired RTI International Metals in a move to expand outside its current businesses.
As a result, current Wall Street expectations have declined steadily since January, with earnings targets falling from 33 cents per share and revenue targets dipping from $6 billion.
The negativity has even sparked significant growth in the number of shorted AA shares. As noted above, AA short interest spiked 51% from 30.5 million shares of 46.1 million shares in the most recent reporting period. The result is a short-to-float ratio of roughly 3.8%, and while this figure is not as extreme as some I’ve written about, it is more than enough to create a short-squeeze situation if AA stock manages a recovery.
Speaking of a potential recovery, AA options data is hinting that short sellers may be a bit nervous about just such a development. Despite the wealth of pessimism being thrown at AA from all sides, the stock’s April/May put/call open interest ratio currently rests at a moderately bullish reading of 0.60, with calls nearly doubling puts among short-term options.
What’s more, this ratio plunges to 0.33 in the weekly Apr 10 series, with calls three times as popular as puts. Keep in mind that the weekly Apr 10 options expire at the end of this week and will be considerably impacted by tomorrow afternoon’s quarterly report.
Overall, weekly Apr 10 series option implieds are pricing in a potential post-earnings move of about 4% for AA stock. This places the upper bound near $14.04, while the lower bound lies at $12.96.
Click to Enlarge Technically, there is little in the way of overhead resistance for AA until the shares reach their 50-day moving average in the $14.67 area, leaving plenty of room for additional upside in case of an earnings surprise.
On the downside, AA has potential support from its 10- and 20-day moving averages, as well as the $13 level, which provided a loose backstop for the shares for most of March.
2 Trades for AA Stock
Call Spread: With most of the company’s bad news already priced into AA stock, Alcoa would have to miss expectations by a wide margin or provide some new bit of poor guidance in order to send the stock down below current support levels. As such, the path of least resistance appears to be to the upside, especially with the potential for unwinding bearish sentiment and a potential short-squeeze.
As such, traders looking to buck the bears and place a contrarian bet on AA might want to consider a May $13/$15 bull call spread. At last check, this spread was offered at 66 cents per share, or $66 per pair of contracts.
Breakeven lies at $13.66, while a maximum profit of $1.34, or $134 per pair of contracts, is possible if AA stock closes at or above $15 when May options expire.
Put Sell: For those traders that want to side with the bulls, but don’t expect an immediate AA rally, a put sell may be just the neutral path you are looking for. At last check, the weekly Apr 10 series $13 put was bid at 13 cents, or $13 per pair of contracts.
As long as AA stock trades above $13 through expiration this Friday, traders pursuing this strategy will keep the $13 premium. However, if AA trades below $13 ahead of expiration, you could be assigned 100 AA shares for each contract sold at a price of $13 per share.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
