A Bull Play on Alcoa’s Tepid Expectations

by Joseph Hargett | July 6, 2012 10:52 am

After the close of trading on Monday, July 9 blue-chip aluminum concern Alcoa (NYSE:AA[1]) will kick off the unofficial start to the 2012 second-quarter earnings season. Analysts currently forecast a year-over-year profit decline of about 80%, with Alcoa seen posting a profit of 6 cents per share compared to 32 cents in the year-ago period.

Revenue is seen falling 11.5% year-over-year to $5.83 billion.

Historically, the aluminum giant is on weak fundamental footing. Alcoa missed the consensus estimate in three of the prior four reporting periods, resulting in an average downside surprise of more than 23% during this time.

Expectations are low on Wall Street, with the brokerage community dropping average second-quarter earnings estimates from 12 cents per share during the past month, thanks to weak aluminum prices and concerns about a slowing global economy. However, unofficial estimates may have sunk even lower, as AA’s whisper number hints at expectations for second-quarter earnings of just 5 cents per share.

Additionally, the brokerage community has issued 12 hold or worse ratings on AA, compared to nine buy ratings. From a contrarian perspective, this configuration leaves plenty of room for potential upgrades should Alcoa manage to best Wall Street’s relatively low earnings expectations.

Meanwhile, short interest has surged more than 12% during the past two months, resulting in 80.65 million Alcoa shares sold short. With more than 7% of its float shorted, plenty of bears could be squeezed into covering their bets following a better-than-expected quarterly report on Monday.

Technically, AA shares have been trapped beneath resistance at the $9 level for the past several months, bouncing along support in the $8.25 region. In a recent show of strength, the stock closed above its 50-day moving average on July 3, marking the first close above this trendline since March 21. This move above former resistance could be a sign that AA is finally ready to leave the $9 level behind.

For those looking to trade AA, the stock’s weekly July 14 options are pricing in a post-earnings move of about 5.9%. Given this data, and the potential for a post-earnings rally, an AA weekly July 14 bull call spread could be potentially lucrative.

The weekly July 9/10 bull call spread was asked at 18 cents, or $18 per pair of contracts, placing breakeven at $9.18 — a gain of about 2.9% from yesterday’s close at $8.92. The maximum loss on this trade is limited to the initial debit, while a maximum profit of 82 cents, or $82 per pair of contracts, is possible if AA closes at or above $10 when these weekly options expire on July 14.

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

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