Using Thursday's Options Activity to Get Ready for Monday's Market

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Includes: AAL, AMD, BIDU, C, JBLU, LUV, NFLX, PENN, SIRI, WFM
by: SA Editor Rocco Pendola

In addition to my own scans and watch lists, I use two main sources to follow options-related news: Daily Seeking Alpha columns by Frederic Ruffy and Andrew Wilkinson. While I get great use out of these sources and have even made money thanks to them, you have to be careful not to chase the stocks or options they mention. Often, by the time you receive an alert or summary, contracts have already had too much volatility and upside priced into the premium. Nevertheless, occasionally, you can find examples to capitalize on. Below I detail options brought to my attention by these sources and how investors might consider playing them - or the underlying security - if at all, during the trading week.

Note: Because the markets close on Friday in observation of the Good Friday holiday, this column appears on Thursday this week.

Penn National Gaming (NASDAQ:PENN). In his column, Wilkinson highlighted bullish options activity in PENN. After the company beat earnings and raised guidance for the quarter and the year, Wilkinson reports that some options traders flocked to May and June $38 calls. On the news, PENN closed Thursday's trading session up to close at $39.98. It hit an intraday high of $40.45 after opening at $38.80.

The conundrum investors face when deciding whether or not to follow the crowd on PENN is, obviously, whether or not the stock can keep up its post-earnings euphoric momentum. Action after Whole Foods (WFMI) last earnings report provides a somewhat parallel case study. When the grocer announced strong earnings in early February, the stock popped on strong volume from its February 9th closing price of $53.75 to a next day close of $60.05. Throughout after hours on the 9th and the regular session when WFMI crossed $60.00, my trader friends and I waited and waited for a meaningful pullback that never really came.

History shows that after about a three-week long pullback into the upper 50s, WFMI reasserted itself back above $60.00 where it holds strong today ahead of its May 4th earnings announcement. Had you gotten into April or May $60 calls, for example, before or just after earnings, you would likely be in good shape today. Whether or not PENN, a company with much less coverage and media exposure, will follow a similar path is anybody's guess. I would err on the side of caution and wait it out upon further review of the company's recent reports. Plus, those PENN May $38 calls tacked on a whopping $1.70 today to close at $2.75, while the June $38 calls last traded at $2.65. I would be shocked to not see at least a little pullback next week or shortly thereafter.

Baidu.com (NASDAQ:BIDU). Ruffy detailed interesting activity on Thursday in BIDU weekly options. On a relatively bullish day among many tech/Internet stocks, BIDU pulled back $0.66 to close the session at $148.65. Ruffy believes action in the BIDU $150 weekly call contracts indicates day trading activity.

If you believe that the China-based Internet search firm will report strong earnings in its April 27th report, you might want to take advantage of Thursday's decline in the price of BIDU call options. Relative to April calls, I would play it safe out to May. In lock step with the decline in the share price, of course, BIDU May call options dipped. For instance, the BIDU May $130, $135, and $145 calls all dropped by $0.40, while the BIDU May $140 calls fell $0.45. Most out-of-the-money contracts for May decreased in value as well, including the $150s, which closed down $0.25 at $7.15.

If you are only moderately bullish on Baidu.com's report, you could execute a bull call spread, which involves buying a call and selling a higher-priced one. To mitigate risk on the downside, you could open a strangle. In this case, you purchase both an out-of-the-money call and out-of-the-money put. All you really need - and will probably get with BIDU - is a wild price swing post-earnings in either direction.

In addition to Seeking Alpha, I use other sources to alert me to notable options trading activity. One of these is Briefing.com's InPlay service. The following note about several stocks crossed the wire today.

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Two stocks from the Briefing report caught my attention today: SIRI and JBLU.

Sirius/XM (NASDAQ:SIRI). I spend quite a bit of time following this company. Not only do I have interest in the stock, but I like what the company does. Plus, I am a radio geek. My Seeking Alpha colleague Cameron Kaine recently wrote a couple of excellent articles on SIRI where he basically predicted the action we are seeing with the stock. While Cameron deserves more credit than I do as a SIRI expert, I must note that despite the angst spewed my way by some SIRI longs, I also noted that SIRI would eclipse the $2.00 mark. Where I differ from Cameron, however, is that I am not as confident as he is that it will stay there. In addition, I am no longer long the stock. I never viewed it as a long-term investment. It hit a profit target for me and I got out. Without discipline, I've got nothing.

Anyhow, SIRI hit a 52-week high on Thursday, closing up 3.2% at $1.93. Briefing pointed out serious call buying in the SIRI May $2 calls and other contracts. A combination of SIRI's recent momentum and optimism over its forthcoming May earnings report fuels the recent bullish speculation. In a way, SIRI is a bit like Netflix (NASDAQ:NFLX). If the company shows impressive subscriber growth, investors might label other not-so-positive areas growing pains. This makes sense, and will pay off, as long as Sirius can execute its long-term plan.

While it's impossible to get a room to agree on SIRI's long-term fortunes, it might be a bit easier to get a lineup of armchair stockpickers to agree on how to play the prospects. When it comes to a play on something short-term such as SIRI May calls that, which effectively hinge on the earnings report, you really should only go in with money you are willing to lose. If by some chance, you guess incorrectly you might have enough time to wait for a rebound to recoup your investment. I learned my lesson the hard way, making bullish plays late last year and early this year to two similarly-priced stocks around earnings, Citigroup (NYSE:C) and Advanced Micro Devices (NYSE:AMD).

Whether you do it now or wait to hear another earnings report, I think the best SIRI calls to play are Jan 2012 and Jan 2013 LEAPS options. By giving yourself some breathing room, you give yourself some protection against any missteps the company may make or investor overreactions in the short-term. If you experience a dip, but remain confident in the original reason why you made your investment, you can always execute what would be a legitimate average down.

Jet Blue (NASDAQ:JBLU). I only mention Jet Blue because the airlines fascinate me. If you are the type of investor who doesn't read the newspaper, watch the news, or research a company's financials, the airlines look like fantastic plays. You would have to hide from the latest oil prices as well. I flew over the weekend from LAX to O'Hare to Buffalo and back. Despite a serious delay in Chicago thanks to thunderstorms Tuesday night, everything went smoothly on American Airlines (AMR). Planes are full, at least from this anecdotal standpoint. Passengers actually seem happier than I recall in previous years. Lines are long at airport restaurants and concession stands. The beer is flowing. Life appears good. But, it's not.

Briefing noted increased implied volatility and larger than normal volume in JBLU May $6 calls after the company reported a smallish profit Thursday morning. Basically, Jet Blue hopes to keep up a shaky balancing act at best by using fare increases to offset the escalating cost of fuel. Southwest Airlines (NYSE:LUV), which also managed to turn a profit, is playing the same game as Jet Blue. Both stocks traded down on Thursday.

I am tempted to dabble in the airline sector as a value play. Even though they both seem to be getting bigger, I like the small players much better than the big boys in this space. It's so much easier to get a handle on their business, plus Jet Blue and Southwest can maneuver a bit more nimbly than American and the other massive operations.

While not sold on the idea just yet, the only way to play the airlines is via LEAPS options. As with SIRI, this route gives you the rewards of being right long-term, but wrong in the short run. You also have to side with oil bears and economy bulls to really go into a play on the airlines with confidence. All else equal, you have a potentially excellent value play. I would go in-or-at-the-money on both stocks. For instance, Thursday's midpoint on the JBLU January 2013 $5 calls was $1.62, while you could have picked up LUV January 2013 $10 calls for about $2.80 apiece. If these airlines can pick up their respective earnings growth pace in 2012, these calls will be worth much more than they are today one year from now.

Disclosure: Author is short NFLX via a long position in NFLX puts.