Look at the Bright Side of Adobe Pessimism

by Joseph Hargett | September 19, 2012 8:31 am

Software giant Adobe Systems (NASDAQ:ADBE[1]) will step into the earnings limelight Wednesday evening to release its third-quarter results.

At last check, Wall Street analysts are expecting Adobe to post a profit of 58 cents per share on revenue of $1.10 billion, up from earnings of 55 cents and sales of $1.01 billion in the same period last year.

Historically, Adobe has been rock-solid in the earnings confessional, besting the consensus estimate in each of the prior five reporting periods.

Despite the company’s prior earnings prowess, however, the brokerage community is far from enthusiastic heading into Adobe’s Q3 report. Specifically, 17 of the 27 analysts following the shares rate them a “hold” or worse. Furthermore, the average 12-month price target for ADBE rests at $37 — a premium of only about 14% to Tuesday’s close at $32.55. This negativity in the face of strong fundamental and technical performance should raise a few flags for contrarian investors.

Speaking of ADBE’s technicals, the stock started off 2012 with a bang, rallying quickly more than 20% to test an area of long-term turbulence in the $35 region. However, the stock’s advance into this region coincided with a period of broad-market weakness, sending ADBE down for a test of key support at $30.

Currently, the shares are on the upswing, riding key support at their 50- and 200-day moving averages. ADBE’s current rally has the shares sitting on a year-to-date gain of about 15%. What’s more, the stock also is within striking distance of the $35 region once again.

Turning to the options pits, short-term traders appear to have sided with the bears in the brokerage community. In fact, the September put/call open interest ratio arrives at 1.59, with puts easily outnumbering calls in this soon-to-expire option series. Taking a closer look, peak put open interest of 7,150 contracts resides at the 33 strike, with another 6,051 puts open at the September 32 strike. Peak call open interest, meanwhile, numbers 4,051 contracts at the 35 strike.

September implieds appear to be pricing in a post-earnings move of roughly 7%. However, since they expire at the end of the week, September options might be too risky for those looking to join the fray ahead of Adobe’s earnings report this evening. As such, October options are likely the best bet as a direct play on the company’s quarterly report.

As I hinted at above, pessimism toward an outperforming stock can be a bullish indicator, especially if Adobe once again bests expectations. As such, buying an October 32/35 bull call spread ahead of tonight’s report could prove quite profitable.

This spread was asked at $1.19, or $119 per pair of contracts, at the close of trading on Tuesday, placing breakeven at $33.19 — a gain of less than 2% from yesterday’s close. Finally, a maximum profit of $1.81, or $118 per pair of contracts, is possible if ADBE closes at or above $35 when October options expire.

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

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

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