Options Update: Applied Material’s Call Traders Posturing Ahead of Earnings

Shares of Applied Materials
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have rallied nearly 13% so far this week, as traders are snapping up the semiconductor concern on the heels of a broad-market rally and an influx of comments from the brokerage bunch. Analyst commentary has been mixed, however. Yesterday, American Technology boosted the semiconductor sector to “equal weight” from “neutral,” upgrading AMAT to “buy” from “neutral” in the process.

This morning, however, UBS cut its price target on the stock from $20 to $15 per share. The equity has shaken off the target cut, rallying more than 6% to challenge short-term resistance at the 13 level. With the prospects of technical resistance giving way in the midst of a strong market rally, bullish investors are diving into AMAT call options today. Specifically, more than 5,700 calls have changed hands so far, more than quadrupling the equity’s average daily call volume and placing the stock on today’s Intraday Volume Explosion List. However, it was the heavy activity at the November 14 call that caught my eye this afternoon.

Applied Materials option volume details

The Anatomy of a Applied Materials Call Position

Diving into the options data, I noticed that nearly all of the AMAT November 14 call volume crossed the tape in 2 large blocks, trading at 9:53 a.m. Eastern time at the ask price. While this volume could be the closure of an existing sold call position, as volume has yet to exceed open interest at this front-month strike, I will be running with a call-buying theme today. From this perspective, it would appear that a trader purchased 1,500 AMAT November 14 calls for the ask price of $0.25. The total outlay for this position would be $37,500 — ($0.25 * 100)*1,500 = $37,500. For this trade to reach breakeven, AMAT would need to rally about 18% from yesterday’s close of $17.98 per share before the options expire on November 21. The maximum loss on this position is limited to the initial investment of $37,500.

By entering this trade, the investor is indicating that he expects AMAT to rally sharply during the next week. The shares have a good head start, with today’s jump of more than 6%, but let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

From a long-term perspective, AMAT has lost more than 31% since January under resistance at its falling 10-week and 20-week moving averages. However, the shares have since outstripped these intermediate-term trendlines, leaving the stock with a little breathing room. AMAT has taken advantage of this slack overhead resistance, rounding from support in the 11 area and overtaking its formerly oppressive 10-day and 20-day moving averages in today’s trading. The stock is now poised to take out the 13 level, which has held AMAT in check since mid-October. A breach of this resistance could clear the way higher for the shares, at least until they are forced to contend with their 10-week moving average in the 14.65 area.

Daily chart of Applied Materials since August 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

Contrarian investors run into a bit of a rough spot when it comes to AMAT’s sentiment backdrop. On one hand, the stock stands to benefit from ratings upgrades, as Zacks.com reports that 8 of the 15 analysts following the shares rate them a “hold” or worse. On the other hand, options traders are heavily bullish on the shares, with the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.62 ranking in the 26th percentile of its annual range. These short-term speculators are clearly looking for an extension of AMAT’s positive price action during the next several sessions. If the security stalls, or is hit with negative news, we could see this bullish sentiment evaporate in the form of selling pressure.

Sentiment indicators for Texas Instruments

Fourth-Quarter Earnings

Just such a game-changing event lies just over the horizon for AMAT, as the company is slated to release its fourth-quarter earnings report on November 12 – a week ahead of November options expiration. Currently, Wall Street is looking for a profit of 14 cents per share from AMAT, down sharply from last year’s earnings of 32 cents per share. Historically, the company has been a solid performer in the earnings confessional, besting expectations in 3 of the past 4 reporting periods by an average of 10%. A positive report here could clearly send the shares sharply higher. However, such a reaction may be muted if options traders continue to place bullish bets on the equity, as such activity ahead of an even is often a sign that investor expectations are relatively high.

The Verdict?

If the broader market holds its bullish bias over the short term, I would expect AMAT to best the 13 level and challenge overhead resistance at its 10-week moving average. However, if we continue to see a rise in optimism among options traders heading into the company’s earnings report, it could be a wise move for contrarian investors to consider a short-term put on the security. The idea is that with so many traders expecting a solid quarterly report from AMAT, anything less than stellar figures could be a disappointment.

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