By: John J. Critchley, Jr.
IBM (IBM) begins the onslaught of earnings in the technology sector as the tech bellwether reports after the bell on Tuesday. Analysts are expecting it to report earnings that are up over 10% from a year ago when it reports its third quarter earnings. The consensus estimate is $3.61 per share, up from earnings of $3.28 per share a year ago. (click here)
The bulls argue that Big Blue has long term growth prospects in four key areas: smarter planet, growth markets, business analytics and cloud computing. To accomplish these growth targets, IBM will need to rely on its historically robust product pipeline, ongoing inroads into the emerging markets and synergistic accretive acquisitions.
The bear argument relies on three negative conditions going forward to adversely impact the upcoming quarters: the premise of slower IT growth, mostly a consequence of unstable macroeconomic conditions; continued above average levels of unemployment and the continuing European debt crisis which has led to unfavorable foreign exchange fluctuations.
Currently, 33 analysts have a rating on IBM with 5 maintaining Buy ratings, 9 Outperform and 19 Holds. There are no analysts with a negative rating on the stock even though the company just pulled back from an all time high and is up more than 11 percent year to date. Over the past year, the stock has underperformed both the Dow and the S&P 500.
However, more importantly than beating estimates and what ratings the analyst community has on the underlying, of course, is how the underlying reacts after reporting. In this area, IBM has a mixed record in the last 5 quarters. The shares have gone higher in the following day in three of the last five reports and lower in the other two quarters.
The average non-directional based percentage move has been 4.29%.
What makes playing IBM's earnings from a long or short only perspective quite tricky is that the company has a mixed history in the underlying movement post earnings.
Confused on what to do with the earnings? Long or short? How about playing both ways?
With IBM trading near all time highs, the implied volatility of the options is quite a distance from its 52 week highs. The 30 day implied volatility is trading around 18.81%, significantly less from the 52 week implied volatility high of 29.70% hit last year at this same time.
Let's take advantage of these reasonable implied volatilities to initiate a position that takes advantage of any post-earnings move in the underlying. If you believe this scenario may play out, let's buy a straddle.
This is not a specific trade recommendation, but a trade analysis.
Trade idea#1-A Short Term Long Options Volatility/Premium Play
IBM options appear to be quite reasonably priced. To find a reasonable pure earnings option play, one could go out to the October '12 monthly options, which present some interesting short term value.
a) Buy October '12 210 straddle for $6.80. The implied volatility of this straddle is seemingly quite high at approximately 33% IV (Implied Volatility). This IV reading is, however misleading because the most important determinant of an options real value as it gets closer to expiration is the premium only, not the actual IV% reading. The premium over parity (POP) number of $6.80 is what is really important.
Net debit: $6.80.
Why the October 210 line? You are buying the At-the-Money straddle for $6.40. The breakevens for this straddle in the underlying are $216.80 and $203.20 respectively. These breakeven points represent a 3.23% move in the underlying. This percentage move does not appear to be unreasonable especially considering that you are buying "event premium" and more importantly from a trading value standpoint, the average non-directional based percentage move post-earnings has been 4.29%.
As an added lure to premium buyers, if there is ever any miss in the numbers on the downside the stock could certainly fall quite precipitously.
Risk: The earnings report does not cause the expected movement in the underlying. Be forewarned. You may lose the entire premium. This play is for speculative monies only.
Notes: Prices quoted where the prices at time of submission and do not reflect current market prices.
We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options.
Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.
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