Zynga (ZNGA) shareholders tiring of the stock’s poor performance are hoping for some fireworks out of Thursday’s earnings announcement. Shares of the ailing social video game company have been wallowing in the mud, unable to escape the $2 price zone.
Unfortunately, strong upside earnings surprises have been a rarity for ZNGA stock, so color me skeptical.
From a tactical perspective, Zynga earnings do provide an interesting trading opportunity for those looking to get in on the action. Despite its low price tag, ZNGA is a very popular stock with active options to boot.
Option prices have climbed in recent weeks, lifting implied volatility to comparable levels seen prior to the past few quarterly earnings. The current IV rank for ZNGA options sits at 72%.
The expected move for ZNGA stock is 30 cents, which translates into a 12% jump one way or the other. With the stock currently stuck in the middle of its one-year range, an earnings gap of that magnitude wouldn’t be enough to escape the ongoing consolidation.
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One of the tricky parts of structuring a trade around Zynga earnings is the lack of premium available in any out-of-the-money options. Even though option strikes are listed in 50-cent increments — $2, $2.50, $3, etc. — the premium available in even the first strike OTM is pennies. With a share price of $2.50, moving 50 cents in either direction constitutes a 20% move for ZNGA stock which is huge.
As a result, we’re relegated to using at-the-money options for our earnings bet.
Straddle ZNGA Stock
I’ll leave the direction guessing of ZNGA’s post-earnings move to the degenerate gamblers among us and focus instead on exploiting the high implied volatility available.
If you’re willing to bet ZNGA gaps less than expected, consider selling the Aug straddle by shorting the $2.50 call and the $2.50 put. With both options priced around 18 cents, you can sell the straddle for a 36-cent credit.
We can add and subtract the 36 cent credit from the $2.50 strike to calculate the expiration breakeven points of $2.86 and $2.14. By selling the straddle, we are essentially betting ZNGA will remain between both those price levels for the next couple weeks.
The max reward is limited to the initial 36-cent credit and will be captured if ZNGA stock is pinned right at $2.50 at expiration.
The max risk is theoretically unlimited but can be minimized by exiting the trade if ZNGA breaks out of its trading range following earnings.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
