Options Update: Straddling General Electric (GE) Ahead of Earnings
Before the opening bell tomorrow morning, blue-chip conglomerate General Electric
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PowerRating) is slated to step into the limelight and release its quarterly earnings report.
Wall Street analysts are currently expecting a profit of 37 cents per share, down sharply from last year’s earnings of 68 cents per share. Historically, GE has matched these expectations in 3 of the past 4 reporting periods, missing by 13.73% in the quarter ending in March 2008, according to Zacks.
However, the brokerage bunch is still downwardly adjusting its expectations, as my colleague Colleen King reported yesterday. Specifically, King noted that “Goldman Sachs and Oppenheimer lowered their earning estimates for GE’s fourth quarter to at or near the low end of GE’s guidance range of 36 cents to 45 cents a share.” Furthermore, UBS placed the shares on a short-term “sell” status, citing a risk to the company’s dividend and top-tier credit rating.
The looming earnings report and the continued barrage from the brokerage bunch has proven too much for options traders to resist. More than 163,000 puts and about 80,000 calls have changed hands on GE so far today, placing the shares on today’s Intraday Volume Explosion List. Making matters more interesting, there were several block trades at the stock’s February 11 put and February 13 call that were marked as “straddles.”
Digging into the activity, the block of 10,000 GE February 11 puts crossed at the ask price of $0.91 at 10:01 a.m. Eastern time. Simultaneously, a block of 10,000 GE February 13 calls traded at the ask price of $1.04. Given that the trades went off at the same time, are of the same size, and that volume at these front-month strikes far exceeds open interest, we are most likely looking at a February straddle for GE. For reference, a straddle is the simultaneous purchase or sale of an equal number of puts and calls on a given underlying stock with the same expiration date and strike prices.
Anatomy of a General Electric Straddle Position
The trade works like this: the trader buys 10,000 GE February 11 puts at $0.91, for a total outlay of $910,000 — ($0.91 * 100)*10,000 = $910,000. At the same time, the trader buys 10,000 GE February 13 calls at $1.04, for a total cost of $1,040,000 — ($1.04 * 100)*10,000 = $1,040,000. The total price tag on the position arrives at hefty $1,950,000. The idea behind this strategy is for GE to move sharply (the direction doesn’t matter) before the options expire next month on Feb. 20, most likely due to a reaction to tomorrow’s earnings report.
For the trade to reach breakeven, GE must either rally about 19% to $14.95 per share, or fall 27% to about $9.05 per share. To arrive at our breakeven target, we add the cost of both options ($1.04 +$0.91 = $1.95) and add/subtract that total to the purchased strikes. For instance, on the call side, we add $1.95 to purchased February 13 call ($13.00 + $1.95 = $14.95). On the put side, we’d subtract $1.95 from purchased February 11 put ($11.00 – $1.95 = $9.05).
Clearly, the trader would need a sizable move from GE. However, given the recent market volatility, and the potential for better (or worse) than expected earnings, there is certainly precedent for such a surge or decline in the equity. As such, let’s see if the stock’s technical picture or sentiment backdrop provide any clues on the potential for sharp moves out of GE shares.
Getting Technical
A look at GE’s technical performance certainly favors the put side of the straddle. During the past 52 weeks, the stock has plummeted more than 62%, pressured lower by its 10-week and 20-week moving averages. Currently, the security is fighting to maintain potential support in the 12.50 region – site of its November 2008 lows. What’s more, short-term resistance is materializing at the 14 level, which also happens to be home to the stock’s declining 10-day moving average. A breach of support at the 12.50 area would be a very bearish signal for GE, as the November lows mark the recent bottom in the overall market.
The Sentiment Drivers
Sentiment toward GE is heavily bearish, and offers potential drivers for a rally on better than expected earnings. First, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 1.54 ranks above 98% of all those taken during the past year. Furthermore, the International Securities Exchange and Chicago Board Options Exchange 10-day put/call ratio of 1.61 ranks at an annual high, underscoring the heavily pessimistic viewpoint of short-term options speculators. While this negativity is warranted given the GE’s abysmal price action, any positive surprises in tomorrow’s earnings report could spark a stampede away from these bearish positions.
Meanwhile, Zacks.com reports that 9 of the 13 analysts following GE rate the shares a “hold” or worse. Upgrades following positive quarterly results are certainly possible, but so too are downgrades should the company miss expectations. Price-target cuts may be much more likely, as Thomson Financial reports that the average 12-month price target for GE rests at $17 per share -a 30% premium to the stock’s Wednesday close at $13.03.
The Verdict?
I normally don’t play options this close to an earnings event; this goes double right now given the recent market volatility. That said, given the potential for the analyst situation to get worse, the stock’s poor technical performance, and the growing troubles with GE’s financial unit despite government intervention, I would have to agree with betting heavily on a continued downside from the shares. Using a straddle position to not only take advantage of such a development while hedging against a potential rally looks like a solid trading strategy at the moment.
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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.