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King Digital: Chance To Long Put

|Includes: King Digital Entertainment Plc (KING), ZNGA

King Digital Entertainment (King) is expected to announce its first earning report tomorrow morning after listing. As its revenue highly depends on the performance of Candy Crush Saga, the earning report is full of uncertainty and we can try to bet on this characteristics.

Two months ago, analysis reports pointed out that the revenue of King dropped 5% from Q3 to Q4. Although it was not a significant drop, Zynga's experience taught us when the lifecycle of a game is towards its end, it is like driving from a cliff. This argument led King's share price to find a bottom until it announces the cooperation of Tencent to develop China's market.

After the announcement, its share price has a short term excitement and then follow a down trend again. Normally, it does not worth longing put option in a down trend as implied volatility is relatively high at this situation.

Yesterday, Pacific Crest Securities published a bullish report with target price of $21. King's closed share price increased by around 8.5%. Most put options expired at 16 May was half price due to inverting price movement and reducing implied volatility.

Therefore, we can bet King's earning report following Zynga's experience with a cheap option premium tonight.

As the uncertainty of its earning is very high, I expect its share price will gap up or gap down at the market opening on Wednesday. Normally, we use Strangle or Straddle Strategy to capture the volatile movement.

However, if thinking of the payoff matrix, the share price has a little higher chance to gap down below $15. Put option with underlying price $15 or $16 can be double or triple at this situation contrary to total loss when it gaps up. Hence, I will long put option of King Digital today.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in KING over the next 72 hours.