A Hedged Play In Zynga Just Ahead Of Earnings

Sep.20.12 | About: Zynga (ZNGA)

With Zynga's (NASDAQ:ZNGA) earnings just around the corner, this is a great time to play the strangle on the options. As a quick explanation, a strangle is buying both a call and a put both out of the money. This strategy allows for a move either way making you money. The idea being that a swing in either direction as small as 10% will cover the expense of both the call and the put, plus some.

Looking at the charts below, it is clear that the stock is struggling to hold on to any kind of value on a day-to-day basis. It has fallen rapidly from its IPO and, oddly enough, is losing less money than many of the other social media stocks that have IPOed recently. Any news that comes out about Zynga or its games sends the stock up into a cloud or down into a pit, depending on the content of the news.

Let's look at Zynga's current status before we talk about the options trade.

In the past month, Zynga has lost the following executives:

  • Wilson Kriegel, former chief revenue officer of Omgpop
  • Zynga Studio Vice President Bill Mooney and Marketing Vice President Brian Birtwistle
  • Chief Operating Officer John Schappert
  • Chief Marketing Officer John Karp
  • Chief Creative Officer Mike Verdu, Infrastructure Chief Technology Officer Allan Leinwand, and General Managers Eric Bethke, Jeremy Stauser, Ya-Bing Chu, and Alan Patmore (who went to rival Kixeye)

Other Items of interest:

  • Purchases include Omgpop and A Bit Lucky, in hopes of bringing both new talent and new games to the holdings.
  • Previous earnings were $0.01 when the consensus was $0.06. Forward expected earnings are paltry at best in the short term.
  • Long-term debt is zero. Total revenue is increasing very quickly, but net operating and net income fell tremendously last quarter.

Based on last quarter's worse-than-expected earnings report and the considerable amount of higher-level folks walking, I began to wonder (and I think a lot of others have too) if there is something going on behind the scenes at Zynga. Could the company be headed to even lower long-term prices?

Another thought I have, without trying to peek into the personal feelings or morals of the execs who left, is if it's possible that all this attrition may have to do with Zynga trying to get into the gambling market. Zynga has seen the go-ahead nod from the DOJ to allow states to draft and enact legislation for legal online gambling with real money. If this begins, it will indeed be big business. No matter what side of the moral debate you come down on, gambling is huge business. If Zynga can get its foot in the door with the fantastic slot and poker-style games now, when real money is allowed it will be a easy switch.

But the focus of this article is not to get into the depth of the possible goings-on, just to touch on them and set the stage to show that come this quarterly meeting, we may see some very exciting or some very disappointing news.

As of this writing, Zynga is at $3.19, with the Oct. 20, 2012, $3.00 put running ask of $0.17 and a bid of $0.16, and the Oct. 20, 2012, $3.50 call at an ask of $0.16 and a bid of $0.15. We would buy 100 contracts of each for a total of $3,200.00 layout (assuming $0.16 for both the call and put). Current IV (implied volatility) is 70.5%, with historic volatility at 88%. Open interest is 4,797 contracts for the put and 11,391 contracts for the call. Based on the open contract numbers, it looks as if more folks are feeling the stock will rise above $3.50 than feel it will fall below $3.00.

Profiting on the put side:

  • Should the stock fall below the $3.00 mark, the put contact will override total outlay at about $2.85
  • At $2.50, the put contract will be worth $0.53 (a total return of $2,100.00)
  • At $2.00, the put will be worth $1.00 (a total return of $6,800.00)

Profiting on the call side:

  • Should the stock begin to rise, the call contact will override the total outlay at $3.65
  • At $3.85, the call will be worth $0.51 (a total return of $1,900.00)
  • At $4.00, the call will be worth $0.62 (a total return of $3,000.00)
  • At $4.50, the call will be worth $1.04 (a total return of $7,200.00)

A few things need to be said here about the value of options and the calculation:

  • For those who are doing the calculation, make sure you only assume 20 days remaining for the options value since earnings are supposed to be posted on the 1st.
  • Options also figure in the volatility of a stock, and the further away you move from the strike the less that movement has on the price. Hence, the reason I stopped showing the values at the point I did, as from there the option movement will be tied to the stock movement close to penny for penny. That is, at $5.00 stock the option will be valued at $1.51, and the same movement applies to the put contact. A return of 100% is quite easy to achieve using this method; with the volatility of the stock price, it only takes a 20% move in the stock price to equal a 100% gain in profit.
  • You do not need to purchase 100 contracts to do this, even just one contract can be purchased or 1,000 if you choose. The number of contracts just happens to be my own play on this stock right now. (Yes, I truly own the items I write about.)

With the recent news of so many top-level executives leaving the company, the possibility of real online gambling happening, the recent drop in the stock price, and the overall market disdain regarding recent social media IPOs, I think this will be a great strategy to take advantage of a swing in the movement of Zynga.

Disclosure: I am long ZNGA. I am long and short ZNGA options. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.