Few stocks have disappointed investors to a greater extent than the disk-drive makers Seagate Technology PLC (STX) and Western Digital Corp (WDC), but that may be setting an up a trading opportunity surrounding the companies’ upcoming earnings reports.
Both STX and WDC have declined more than 25% in 2016 after posting losses of more than 40% last year, reflecting investor concerns about slowing sales and rising competition from flash drives. Earnings estimates have fallen in kind, with both Seagate and Western Digital seeing sharp reductions in the consensus 2016 EPS expectations in recent months.
Clearly, expectations have fallen through the floor: Seagate and Western Digital shares now trade with a forward price-to-earnings ratios of 6.8x and 6x, respectively, with yields of 8.5% and 4.3%.
With this being the case, next week’s earnings reports become an interesting play for traders.
Trading Seagate Technology (STX) and Western Digital (WDC)
Western Digital reports after the close on Thursday, Jan. 28, while Seagate reports before the bell the next day. Both stocks offer meaningful short-term upside potential if earnings come in above expectations or are simply “less bad” than investors fear.
At the same time, the stocks’ poor recent price performance and low valuations indicate a more limited degree of downside risk. WDC has met or exceeded expectations in three of its last four reports, while STX has come in ahead of the consensus in each of the past three quarters.
Traders can play this favorable risk/reward set-up through options on Seagate stock, particularly in-the-money February calls (which expire on Feb. 19). This approach provides exposure to the a relief rally associated with the reports, while also offering a modest time cushion offered by the 15 trading days between earnings and expiration.
If you’re an experienced trader who can handle the risk, put this idea on your radar screen for next week.
As of this writing, Daniel Putnam did not yet hold a position in either of the aforementioned securities.
