JA Solar – Earnings Options Play
Joseph McKim(Teemoney)
JA Solar (ticker:JASO)is a manufacturer of high-performance solar cells based in People's Republic of China. With LDK Solar producing good earnings results last week, it sets the stage for an upswing in the lagging solar sector. With that in mind I’ve designed a few plays to take advantage of a rise in JA solar, as well as play’s to take advantage of any undesirable price movements along the way. Fundamentally JA Solar is undervalued, and historically the company has been conservative on earnings estimates. Similar to the DryShips(DRYS) play I did a few months back, we are aiming to take advantage of a surge of interest in the Solar Industry during earnings season, while focusing on a well run but fundamentally undervalued company. Downside risk if played correctly with stop losses should be minimal with the exception of a total market correction/crash. When looking at options for JASO we are aiming for something with plenty of time till expiration and already in-the-money. This will be considered our core position and we will trade other options around these. For JA Solar I like the June 18 $6 calls. Currently they are around 2-2.1 apiece. These June options are roughly .2 more than the March 19th options but have an additional 60 days of time till expiration. JASO announces earnings in 3 weeks so we will lose MINIMAL time value in these options while waiting for price movements in anticipation of earnings. Additionally the March calls have only 1 earnings announcement till they expire, meaning they will lose a great deal of value to implied volatility after the earnings announcement while the June calls have 2 earnings announcements and as such will retain almost if not all of their value. These are the things that you want to consider when buying/selling options around earnings announcements, even if you have 60 days till expiration, an option will lose a pretty hefty chunk of its value immediately on the release of these earnings due to the nature of implied volatility and the fact the good/bad earnings releases move a stock price much more than any given day of the week. So with that in mind we buy the $6 June in-the-money calls and wait. Now these are the plays we will trade depending on the movement of the stock.
Scenarios
-Stock continues to climb up until earnings, with minor pullbacks(ideal 25-100%+ return) – If this were the situation to arise we would continue to accumulate the June 6 calls on pullbacks up until earnings announcement. This is the ideal situation because we can sell all or almost all of the position (depending on how bullish you are) BEFORE earnings are announced. The day before a company announces earnings are when the options are valued the most. This is due to a large influx of investors buy short-term high-risk options in anticipation of huge increase/decrease of the stock price due to earnings and this drives up the implied volatility of ALL the options on stock. That’s the beauty of buying long term options, they function almost exactly like outright stock but you have the added advantage of price swells when volume increases regardless of stock price movement. Keep stop losses at roughly 25% of the options price, or as I do, convert to trailing stop losses(which get tighter as the option grows in value) once you’ve become profitable on the trade. If you like to gamble let some of the profits ride through earnings as you might get lucky. I’m setting an ideal price target of $9-10 a share which would almost double the value of the current options.
-Stock has a larger than normal pullback then rises or stays flat till earnings(10% or greater return) – While not ideal this situation is not entirely undesirable. This scenario is why we look for fundamentally undervalued companies to play. When playing fundamentals as opposed to technical’s, a stock can only lose so much value in a bull driven sector before it refuses to go lower. We saw almost the exact scenario happen last quarter with the Dry-Bulk shipping sector. The Baltic index was tanking yet almost every single shipping company gained a pretty hefty amount of share value. This is a great way to eliminate a lot of downside risk, and as we saw with DRYS, a 120% return was achieved in 2 weeks. If the above scenario were to occur there is a very good chance we will hit our stop losses. The way the core position is designed is to trigger our stop-losses when JASO trades right around 7 dollars a share. At that point we would SELL the June $6 PUTS on JASO. Based on experience and timing these will be worth be worth around .75-1.00 apiece. The losses from the calls would be more than paid for by the sale of the puts giving you an immediate 10% return. However if this were to happen as I am bullish on this company I would not only sell the puts but buy back the June 6th calls for a lower value. It should be noted the puts must be held until expiration unless the stock rises, however say a worst case-scenario does occur and the Puts are exercised, you get the added benefit of owning JASO shares outright for $5 dollars a share($6 minus the sale of the puts). That’s 35% off its current stock value! I can’t speak for you, but I sure as hell don’t mind owning a stock for 35% of its current share price.
-Stock stays flat up until earnings(5-10%) – This is undesired, however if this were to occur we would hold the options until earnings then sell on the day before or day of earnings and very likely take a small profit from the swell of implied volatility of the options.
-Stock corrects 10% and then drops even more before earnings(loss) – This event would only occur during a crash, or if very bad news were announced before earnings. Stop losses triggered on a bad news report are situational and not something I can plan for, at this point you take a loss. While certainly possible, this is considered static risk, and the odds of it occurring are about the same for any company. We do have the advantage of owning a fundamentally undervalued company in a bullish sector BEFORE earnings and while I can never guarantee you will make money on a trade, I can say the odds are stacked in your favor.
Things to keep in mind
- Set your stops, options move in greater price swings than normal stock so we need more room for that movement to occur. A 25%-30% stop gives you enough room for the stock to move up to a 10% loss off the share price. If stops are hit prematurely you can buy back in.
- ALWAYS buy your options in the middle of the day when volume is lowest. Market-makers on average, markup options 10% or more(depending on volume) in the first 2 hours or last 2 hours of EVERY day. It is very easy to buy an option at 10 am and be down 10% by noon without the stock price moving at all. However knowing this ALWAYS sell your options in the first 2 hours or last 2 hours of the day.
- Remember, anytime you are satisfied with profits, TAKE THEM. This position is not designed to be held through the earnings announcement, the June 6th expiration was chosen to minimize time decay and volatility decay in your position while taking advantage of leverage in a bullish movement until earnings. If however, you want to gamble on earnings, you can do so with trailing stops, or hedge with short term cheap-o puts. Just remember a stock is just as easily bought after earnings as it was before, protect those profits.
- I also realize there are other companies undervalued in the Solar industry, I like JA Solar due to its share price as it doesn’t tie up as much margin as say Trina Solar would. It should be noted you can play a company like Trina Solar(Ticker:TSL) almost the exact same way as it wouldn’t incur any greater risk than JASO, just margin.
Disclosure: I am long JASO.