Options Update: Put Volume Spikes on E-Trade Financial Ahead of Earnings

Shares of E-Trade Financial Corp.
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are fighting to stay out of negative territory this afternoon, after the stock received a price-target cut to $3.00 per share from $4.00 per share at UBS. The brokerage firm held its rating on the equity at “neutral.” The move comes just days ahead of the company’s third-quarter earnings report, scheduled for Tuesday, October 21.

Analysts are currently looking for a loss of 26 cents per share from ETFC, widening from last year’s loss of just 6 cents per share. The company’s earnings history does little to embolden bullish investors, as ETFC has missed expectations in 3 of the past 4 reporting periods. What’s more, the E-Trade’s has missed Wall Street’s views by an average of 30% in the past year, with the company’s second-quarter report falling short by more than 71%.

With ETFC’s third-quarter looming on the horizon and the firm’s poor fundamental track record, it should come as no surprise that put options are the soup de jour. In fact, more than 19,000 of these bearishly aligned options have changed hands on the stock so far, outpacing ETFC’s average daily call volume by a ratio of 12-to-1 and placing the shares on today’s Intraday Volume Explosion List. But it was the roughly 11,500 put contracts that traded on the security’s November 3 put that caught my eye> today.

E-Trade Financial option volume details

Time for a Roll Out

Taking a closer look at today’s unusual option activity for ETFC, I noticed that nearly all of the November 3 put volume was marked “spread” on the exchange. Checking the stock’s other strikes, I found the related trades on ETFC’s October 3 put. In the chart above, there are several large blocks listed that changed hands at 10:39 on both the October 3 and November 3 puts, hinting that these blocks were related. However, after sorting through the bid/ask data, it appears that we are looking at a roll-out of a rather large put position on ETFC from October to November.

The first sign that we are looking at a roll-out of an existing position is that October options expire this Friday. As such, today’s bid activity on the October 3 puts is likely the closure (i.e. sell to close) of an open position. Furthermore, volume at this front-month strike totals less than open interest, providing additional evidence of a position closeout.

Meanwhile, volume at the November 3 strike easily outnumbers the measly 1,652 contracts currently open at this back-month put. What’s more, these blocks traded at the ask price, supporting the idea that they were purchased (or bought to open). Combine this data with the fact that all of the blocks listed in the chart above crossed at the same time on the same exchange, and we are probably viewing the roll-out of an 11,421-contract position from October into November. For today, we’ll use the activity at the November 3 put as an example of a ETFC put position. Let’s see how the trade actually plays out:

The Anatomy of an E-Trade Put Position

The trader purchased 11,421 ETFC November 3 puts for $0.65, for a total outlay $742,365 — ($0.65 * 100)*11,421 = $742,365. For this trade to reach breakeven, ETFC would need to drop about 22% from yesterday’s close to trade at $2.35 per share. We arrive at this by subtracting the cost of the option ($0.65) to the strike of the purchased 3 put ($3 – $0.65 = $2.35).

On a side note, since today’s hypothetical trader was rolling out an existing position, the total cost for the November 3 puts was offset by the sale of his October 3 puts. We arrive at breakeven for this rolled position by subtracting the difference ($0.65 – $0.45 = $0.20) between the October 3 put ($0.45) and the November 3 put ($0.65) from the purchased 3 put ($3 – $0.20 = $2.80).

If the trader is looking to take advantage of any decline in the shares from a potential earnings miss, then a roll out is a perfect way to capitalize on next week’s event. That said, let’s see exactly where ETFC stands from a technical and sentiment standpoint.

Getting Technical

Technically speaking, the prospects for a profitable November 3 put look pretty good at this point. ETFC remains locked in a steady downtrend under the resistance of its 10-week and 20-week moving averages. The shares have stair-stepped lower since the beginning of the year, holding first to support in the 4 region, then the 3 level, until finally breaching these areas and heading lower.

The next appropriate backdrop for ETFC appears to be the 2 level, which held as support for the shares during last week’s sharp plunge in the overall market. However, the 3 level is now providing technical resistance for the shares, which should work in favor of a purchased November 3 put. Furthermore, a pullback to the 2 level would be a 24% decline in the shares, easily eclipsing the 22% drop needed to place the short position in a profitable position.

Weekly chart of E-Trade Financial since June 2007 with 10-week and 20-week moving averages

The Sentiment Drivers

Given the current market environment, it should come as no surprise that there is a heavy degree of pessimism levied against EFTC. Short interest accounts for more than 17% of the stock’s total float, while Zacks.com reports that all 10 analysts following the equity rate it a “hold” or worse. However, with ETFC down more than 79% in the past 52 weeks, this negativity is par for the course and poses little in the way of a contrarian read. The only exception to this assessment would be a strong earnings report from the company next week.

What is shocking is that options traders are not on the same page as short sellers and Wall Street analysts. In fact, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.38 indicates that calls nearly triple puts among near-term options. What’s more, this ratio is lower than 75% of all those taken during the past year, meaning that speculative traders have been more bullish toward ETFC only 25% of the time in the prior 52 weeks. Should this ratio fall heading into next week’s earnings report, it could be a signal that investor expectations for E-Trade’s earnings report exceed those among Wall Street analysts. Such a scenario could set the stock up for a negative reaction to the report, thus benefiting a purchased ETFC November 3 put.

Sentiment indicators for E-Trade Financial

The Verdict?

Even with a stock trading in the $2-$3 range, a 22% move is nothing to sneeze at, as it takes a considerable jump from investors to create such a move. That said, we have seen no end of such moves during the past 2 weeks, and the continued instability in the financial sector hints that we may experience other such moves. ETFC’s earnings report next week complicates matters further. A poor report should be a non-event unless expectations among options traders soar significantly in the mean time. Meanwhile, a strong report could mean a total loss on an ETFC November 3 put. If I were rolling a position out from October, I would give such a trade serious consideration due to the capital already invested. From a “standing start,” there are better opportunities to be had, even in the financial sector.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.