With earnings season in full swing, there are tremendous opportunities to take advantage of the volatility created by anticipation of earnings announcements. Specifically, when an earnings announcement is imminent, the market anticipates that the stock could move drastically one way or the other, so option premiums increase. This week has a full calendar of earnings announcements, with 120 publicly traded companies announcing on Monday alone. This article will focus on 2 of my favorite companies to watch during earnings season, Baidu (BIDU) and Las Vegas Sands (LVS).
1) Baidu - The world's leading provider of Chinese language online search services is a long way off from its all-time high of $165.96 which it briefly reached this July. Baidu currently trades at 29 times TTM earnings, which is rather modest considering that it has grown it's earnings and revenue by 74% over the past 12 months. Baidu has also been highly reactive to earnings announcements, averaging over a 10% move within a week after an announcement.
Analysts believe the stock to be undervalued at current levels, as the followers of the company currently have an average price target of $156.30 on the company, which represents a potential upside of 37.3% over current levels. For this reason, I want to play earnings with a cautiously bullish options trade. Since I believe that there is a very small chance of a large downside move, I want to sell the $110 weekly puts for $2.65. If I'm right, the contracts expire worthless come Friday, and the premium collected is mine to keep, a 2.4% gain on my money in one week. If I'm wrong, I am forced to buy the stock, however at the very attractive entry price of $107.35. In other words, this trade makes money as long as the stock either goes up, stays the same, or goes down by less than 6%. Not a bad risk/reward.
2) Las Vegas Sands - One of the leading casino operators in the world, LVS operates several well-known casinos in Las Vegas (The Venetian, Sands, and Palazzo), as well as locations in Macau, China and Pennsylvania. They are also developing a casino resort in Singapore, where they hold one of only two gaming licenses and opened the first phase of the resort in 2010.
Analysts expect growth to depend strongly on the performance of the Macau locations, which are growing rapidly as a result of the rise of Chinese disposable income. LVS is projected to have an 18% growth rate over the next 3 years, which justifies its P/E multiple of 19.3. This makes me very bullish on the company over the long term, however LVS tends to be much less reactive towards earnings reports than BIDU, averaging only a 3.4% move within a week after earnings.
For this reason, I believe this is an excellent chance to take advantage of the increased implied volatility, as history tells us that a relatively flat PPS after earnings is the most likely scenario. In fact, the largest post-earnings move in the past year was only 5.4%. I want to create an in-the-money call spread and an in-the-money put spread to "play the middle."
On the call side, I want to buy the $44 weekly calls for $2.44 and sell the weekly $45 call for $1.72, a net cost of $0.72. On the put side, I am a buyer of the weekly $48 put for $2.40 and a seller of the $47 put for $1.71, a net cost of $0.69. This is a total initial cost of $1.41, and the beauty of this trade is that the minimum value of the position at expiration Friday is $1.00. There is no possibility of getting wiped out on both sides, limiting the potential losses on this trade to $0.41 if I'm wrong and the stock moves considerably in either direction. Maximum profit of $0.59 is achieved if the stock is between $45 and $47, and the breakeven points are $44.59 on the downside and $47.41 on the upside, which represents a 3.1% move in either direction.
I love this trade because even though the trade costs $1.41 to place, in a worst-case scenario, the maximum you can lose is 29% of that, and the maximum profit of 41.8% creates a very favorable risk/reward spread.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.