Dining on Darden Options Ahead of Earnings

by Joseph Hargett | June 21, 2012 9:37 am

Darden Restaurants (NYSE:DRI[1]) — the company behind chains such as Red Lobster, Olive Garden and Longhorn Steakhouse — is scheduled to release its fiscal fourth-quarter earnings report ahead of the open tomorrow morning. Wall Street is expecting earnings of $1.16 per share from the restaurateur, an increase of 16% over the same quarter last year, but a figure that’s down from $1.18 just three months ago.

Revenue is expected to rise 6% to $2.11 billion from a year ago.

Historically, Darden has been far from impressive. During the past four reporting periods, it has topped the consensus estimate once, matched expectations twice and missed Wall Street’s targets once. The result is an average downside surprise of about 1%.

Despite this relatively in-line fundamental history, the brokerage community appears to have elevated expectations. For instance, 17 of the 28 analysts following DRI rate the shares a buy or better, compared to 11 holds, and absolutely no sell ratings. This configuration leaves plenty of room for potential downgrades should Darden’s quarterly report come up short.

Options traders are trending toward the opposite end of the sentiment spectrum, however. Specifically, yesterday’s put/call volume ratio ballooned to a hefty 2.32, with put volume more than doubling call volume on the session. Furthermore, the put/call open interest ratio for the July and August options series comes in at 0.83, with heavy put accumulations dragging the reading higher.

Peak put open interest lies at the July 47 strike, totaling 9,924 contracts, followed distantly by July 50 put, where 3,086 contracts reside. On the call side, traders are heavily targeting the out-of-the-money July 55 strike, with 13,823 contracts open. The July 50 and 60 strikes are also notable, with more than 3,000 calls open at each.

So, when trading DRI ahead of earnings, do we follow the brokerages or the options community? The stock’s short-term technical backdrop supports the bullish case. DRI has bounced around between the $49 and $50 levels for much of the past several weeks, but the equity has recently rebounded off the lower rail of this range, reclaiming its 50-day moving average in the process. The shares have spent the past three days consolidating into this supportive trendline, hinting that another upleg could be in the making.

Looking at July options implieds, it appears that traders are pricing in a post-earnings move of about 7.9%. Therefore, a July 50/55 bull call spread could be quite profitable. This spread was offered at $2.20, or $220 per pair of contracts, at the close of trading on Wednesday. Breakeven lies at $52.20 — a 1.5% gain from yesterday’s close — while a maximum profit of $2.80 is possible if DRI closes at or above $55 when July options expire.

Joseph Hargett holds no open positions on any stocks, securities, or options mentioned above, nor does he have plans to enter such a position in the next 72 hours.

  1. DRI: http://studio-5.financialcontent.com/investplace/quote?Symbol=DRI

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