By John Critchley & Christopher Yip
MetroPCS (PCS) reported earnings before the market open on Tuesday this week and although posting higher earnings quarter over quarter, they missed estimates and announced a dismal outlook for the remainder of the year. Second quarter EPS came in at $0.24 missing expectations of $0.29 per share or about $17.9 million shy of estimates. PCS shares dropped as much as 35.5% after the market opened, falling from a previous close of $16.2 to $10.44 before catching ground and stabilizing. PCS is one of the more popular cellular service providers specializing in month-to-month plans with no annual contracts and no early termination fees. The downside to this convenience and freedom is the quality of service and the limited coverage area. Most existing customers complain about the difficulty in finding a signal even in densely populated areas such as New York City, New Jersey, Philadelphia, and Boston. Furthering their case, customers frequently experience dropped calls and poor connections.
The low priced plans are attractive to young individuals, specifically high school and college students, and recent graduates who are either cost conscience or working with tight budgets. With such a young crowd making up for more than 50% of the PCS customer base, this makes forecasts and trends very difficult to predict accurately. Which helps explain why the PCS churn rate may have missed the mark this past quarter. In the face of tougher economic conditions, young individuals using PCS may opt to skip a month or two of cellular service by temporarily suspending their line of service. And with no termination fee and only $15 to reconnect a suspended line, this option can potentially save a typical user $85 over the course of two months and makes for a very sneaky yet chic way to rack up savings. As PCS explicitly pointed out in its forward statement, economic uncertainty and poor job growth within the U.S has hindered the growth rate of customers and will ultimately affect the original FY2011 estimates.
Across the lower end cellular service providers, shares of Sprint (S) and Leap Wireless (LEAP) both took a hammering as well. LEAP-ing off a cliff in sympathy with PCS, LEAP shares lost 19% of its market value following PCS’ earnings in early trading Tuesday. Sprint had announced earnings last week and gapped down from $5.16 to $4.23 last Thursday after revealing a loss of customers and a worse than expected EPS. But this is no indication that telecom giants, AT&T (T) and Verizon (VZ), are out of the woods. Shares of both companies have pulled back in the past few weeks, retreating about 6%. AT&T’s next earnings release is scheduled for October 17th, with Verizon following closely behind on October 21st. Unlike little siblings PCS, LEAP, and S, big brothers AT&T and VZ both issue dividends over 5% and are often treated as safe stocks in the advent of a sour market.
From an option trading standpoint, the real question is what are the chances that the stock stays around $10? With PCS plummeting following earnings, the 30 day implied volatility of the options is near its’ 52 week highs. The 30 day implied volatility is trading around 56.9%, significantly higher than the 52 week implied volatility low of 30.54% hit in May of this year. The argument that implied volatility is too high is not hard to make – they just released earnings, the news is out. However, the opposite argument that implied volatility is too low or just about right is just as convincingly made – where the stock goes from here, no one knows; this just isn't a stable underlying. Quite understandable considering the massive collapse in the underlying and the uncertainty of the company going forward. Is the business model broken and the stock has further legroom to fall? Or does the depreciation in share price make the underlying a possible takeover candidate and ripe pickings for bargain hunters?
If you believe in either scenario and are in the camp that PCS will continue to be quite volatile, the buying of options at this level is a reasonable option play to take advantage of the unclear future of PCS.
Let’s take advantage of these uncertainties to initiate a brand new long implied volatility position in PCS.
Trade idea -An Options Play
To find the most reasonable implied volatility option plays, let’s go out at to the Sep ’11 options, which present some interesting medium term value.
a) Buy September 10 straddle for $1.50. Paying about 50.10% in Implied Volatility.
Net debit: $1.50
Breakeven point: $8.50 or $11.50 in the next 7 weeks.
Why September? Normally, one would buy the front month options if they believed that the underlying would move in the near term. This however is not always the optimal option trade. The implied volatility of the front month August options is significantly higher than the September options. The August 10 straddle is currently trading at $1.20 or 58.08% implied volatility. The September straddle is trading at an implied volatility that is nearly 8% cheaper then August. Quite an attractive discount. Let’s take advantage of this calendar differential and buy the September straddle instead of August.
Stay tuned ...
Notes: Prices quoted are accurate at the time of writing and are subject to change after submission to Seeking Alpha.
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