Trina Solar Straddle: Make Some Bucks on Expected Volatility

Jul.29.11 | About: Trina Solar (TSL)

Trina Solar Limited (TSL) is an integrated solar-power products manufacturer based in China with a global distribution network covering Europe, North America, and Asia. It produces standard monocrystalline photovoltaics.

If you’ve seen any of the headlines, the solar industry took blows in the second quarter. Demand has declined and inventories have piled high. Yet some companies, particularly GT Solar (SOLR), now GT Advanced Technologies, seem capable of weathering this potentially strong hiccup. SOLR is diversified across several industries including the hot LED market. Dr. Duru has recently argued that now is a great time to pick up some of SOLR's stock, especially in light of the flurry of recent solar analyst downgrades. TSL was downgraded on July 28 by Collins Stewart, a “Star Analyst” on Yahoo Finance.

I agree with the doctor. Solar is here to stay, and it is only a matter of time before this industry adjusts to its supply glut — which markets always find a way of doing — and continues growing.

Recently Chinese solar companies have been fraught with audit scandals as chairmen and members resign. LDK was hit hard when its audit head resigned, and TSL experienced its largest stock drop of the year (11% with over 14.5 million shares traded) when its audit committee chair, Peter Mak, resigned on July 12 to focus on personal and professional matters. Mak’s past was marked by his work with A-Power Energy Generation Systems Ltd., whose audit reports have been delayed.

The fog of uncertainty has shrouded the earnings expectations of the solar industry, and there is nothing the market hates more than uncertainty.

What’s an investor to do? Straddle.

TSL is widely recognized as one of the leaders in the solar industry and a very strong company. Sabrient currently rates it as Strong Buy. While its growth score of 66.7 is just shy of the industry’s 68.4, it has nearly the highest possible value score of 99.7. With a 36% stock price drop in the last three months, no wonder it’s a good value. What remains is a dismal momentum score of 14.9 compared to the industry’s 38.9, and a low earnings score of 26.3 compared with the industry’s 59.6. However, it is redeemed by its fundamental score (a broad measure of financial health including balance sheet, cash flow, revenue, and earnings quality) that beats the industry by over 30 points. (All scores are out of 100.)

China’s on-grid installations are expected to double in 2011 due to incentive policies for large scale PV installations. The latest Solar Buzz report sees global demand spiking to 25% in 2015 from 11% in 2010. That’s all fine and dandy but a long way off.

The company is an excellent value, no question. But the question is when it will rebound. TSL’s August 20 earnings call is approaching, and I do not know which way it will go. This calls for a straddle, no put intended.

On May 17, TSL’s first quarter earnings volume was 7.6 million. I already mentioned that over 14.6 million shares were traded following the resignation of the audit chair. I think we can expect a lot of volume on August 20, and the way to benefit from this uncertainty is a straddle.

A straddle involves purchasing a call and a put with the same strike price and expiration date and then capitalizing when you see one gaining more value than the other. Right now, puts are more expensive than calls; the market is expecting TSL to continue to fall. The closest option is August 11, which is before earnings. I’d recommend a September 11 option. If you’re following TSL, you’ll drop the call or the put depending on whether bears or bulls are running right after earnings are announced.

Rather than risking a long investment in TSL before earnings, this lower risk investment could only end up costing you the two premiums combined if the stock doesn’t make an extreme move one way or the other. The underlying problem to a straddle of course is filling your put and call option orders reasonably close together. But with the current uncertainty, it is a viable choice to make.

Below is a straddle view of puts and calls I pulled off of Yahoo Finance following Thursday’s close. TSL closed at 17.83.

[Click to enlarge]

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.