Alcoa Inc. Kicks Off Earnings Season: 2 Trades for AA Stock

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Alcoa Inc. (AA) will kick off the unofficial start to third-quarter earnings season after the close of trading on Wednesday. The aluminum giant has been pressured this year by a strong U.S. dollar and slowing demand, forcing the company to trim high cost operations, sell low value assets, and focus on lower-cost production.

Alcoa stock upstream AADespite these moves, AA stock bears smell blood in the water, but are they too late to the game?

By the numbers, Wall Street is looking for fiscal second-quarter earnings of 23 cents per share from Alcoa — up 28% from year-ago levels.  Revenue is seen arriving down 1% at $5.8 billion. However, whispers are swirling that Alcoa will miss earnings targets, with EarningsWhisper.com reporting a whisper number of just 21 cents.

Bearish sentiment has begun to take hold in the analyst community for AA stock. The last several moves within the community have been downgrades, resulting in eight “hold” or worse ratings and 10 “buys,” according to data from Thomson/First Call.  Meanwhile, the 12-month price target currently rests at $16 per share.

Pessimism is also swelling among short sellers. Specifically, the number of AA shares sold short surged by 23% in the most recent reporting period. As a result, some 72.5 million shares of AA stock, or nearly 6% of the stock’s total float, are now sold short.

But, judging from recent options activity, there may be a lack of conviction from the short-selling crowd.  Typically, short sellers will buy short-term call options as a way to hedge their bets, especially ahead of events such as earnings reports.

Along these lines, AA stock’s July/August put/call open interest ratio has fallen to a reading of 0.41, with calls more than doubling puts among options set to expire within the next two months. Taking a closer look at just July options, the put/call open interest ratio falls even further, arriving at 0.38.

AA 7-6-2015
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 Overall, weekly Jul 10 series implieds are pricing in a potential post-earnings move of about 5% for AA stock. This places the upper bound at $11.54, while the lower bound lies at $10.46.  Historically, implieds seem a bit on the low side, meaning that AA option prices may be low at the moment.

Technically speaking, AA stock is trading deep in short-term oversold territory. The stock is currently perched just above its 2014 lows, which currently correspond with potential support from AA’s 200-week moving average. Despite the overwhelming negativity levied against AA, there is a possibility of a surprise post-earnings rally.

2 Trades for AA Stock

Call Spread: Pessimism toward an underperforming stock is largely par for the course, and AA stock has earned much of its negative reputation on the Street.  However, the recent selloff has placed AA in oversold territory, hinting that the stock’s recent losses may be overdone.  As such, there is the possibility of a snap-back rally for AA following this week’s earnings report, especially if there are any positive nuggets to be gleaned.

As such, traders wanting to take a chance on an AA rally might want to consider a Jul $11/$12 bull call spread.  At last check, this spread was offered at 31 cents, or $31 per pair of contracts. Breakeven lies at $11.31, while a maximum profit of 69 cents, or $69 per pair of contracts, is possible if AA stock closes at or above $12 when July options expire.

Straddle: Alternately, traders with a higher risk tolerance might want to take advantage of this high volatility situation and enter a straddle. A straddle involves the simultaneous purchase of an at-the-money call and an at-the-money put in an attempt to take advantage of a greater than expected move from the underlying stock.

By employing a straddle on AA stock, you are likely betting that the company is going to either handily beat earnings expectations, resulting in a reversal of sentiment and a rush in buying activity, or confirm the Street’s bearish bias, resulting in a flood of sell-on-the-news activity. At last check, the AA Jul 11 straddle was offered at 68 cents, or $68 per pair of contracts. Breakeven for this trade lies at $11.68 on the upside and at $10.32 on the downside.

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

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Article printed from InvestorPlace Media, https://investorplace.com/2015/07/alcoa-inc-kicks-off-earnings-season-2-trades-aa-stock/.

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