Options Update: Are AutoNation Shares Stable Enough for a Calendar Spread?
Last Thursday, automotive parts and services specialist AutoNation
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PowerRating) reported a 30% rise in fourth-quarter net income. The company banked an adjusted profit of 12 cents per share, matching analyst expectations. Earnings for the quarter were hurt “by the credit panic triggered on Sept. 15 by the bankruptcy of Lehman Brothers,” said Chairman and Chief Executive Mike Jackson.
Today, speculative traders have zeroed in on AN puts, with more than 20,000 of these bearishly oriented options crossing the tape. In fact, put volume has outpaced the stock’s daily average by more than 15 to 1, placing the shares on our Intraday Volume Explosion List. Nearly all of this activity was concentrated at the February 10 and March 10 strikes. As you can see from the chart below, 2 large blocks of 10,000 contracts each traded at 9:45 a.m. Eastern time, with the February puts changing hands at the bid, and the March puts trading at the ask.
The Anatomy of an AutoNation Put Position
There are 2 potential strategies that could help explain today’s unusual AN put volume. The first is that the trader is rolling out a front-month position at the February 10 put into a back-month March 10 position. In this case, the trader is expecting AN to trend steadily lower during the next several weeks, and is rolling the position out in order to better capitalize on future losses in the shares.
As such, this trade would work just like any ordinary put-buying position, with the trader doling out $650,000 for the March 10 puts. Normally, buying the March 10 puts would cost a trader $1,650,000 — (1.65 * 100)*10,000 = $1,650,000 — but the total outlay is reduced by the credit received by selling the February 10 puts for $1,000,000 — (1.00 * 100)*10,000 = $1,000,000. For this trade to reach breakeven, AN would need to fall 2.6% from its current trading range near $9.60 per share by the time the options expire on March 20. The maximum loss for the trade, however, remains the total investment of $1,650,000 (not taking into account any losses the trader may have already incurred on the sold February 10 put).
The second strategy involves the initiation of a calendar spread. In a calendar spread, a trader buys an option with a longer expiration and sells an option with the same strike price and a shorter expiration. The idea is for time premium on the shorter-dated option to degrade faster than the longer-dated option. As such, the trader needs the underlying stock to remain relatively stable. Currently, the spread on the February 10 put and the March 10 put is $0.65 — $1.65 – $1.00 = $0.65. Due to the complications in calculating a profit/loss on a calendar spread, please refer to our education section for more information on this trading strategy.
So, will AN trend sideways and provide support for a calendar spread, or will the shares extend their long-term downtrend and benefit a purchased March 10 put? The stock has found a pocket of buying strength so far today, and has rallied nearly 3% at last check. That said, let’s see if AN’s technical or sentiment backdrops provide any additional information.
Getting Technical
From a technical perspective, AN has been locked in a sharp decline since June 2007, losing more than 57% of its value during this time frame. Additionally, AN continues to find resistance at its falling 10-month moving average – a trendline the shares have not closed a month above since June 2007. Further complicating matters is staunch round-number resistance at the 10 level. With the stock’s 10-month moving average descending into the region, AN could have a difficult time mustering a compelling rally.
As a caveat to this dismal long-term outlook, the stock has rebounded nicely from its late October lows. What’s more, AN seems to have established short-term support in the 7.50-8 region. With resistance growing at the 10-10.50 area, and potential support in the 7.50-8 region, the shares look to be range-bound from a short-term technical perspective.
The Sentiment Drivers
Sentiment toward AN is skewed toward the bearish end of the spectrum. Currently, all 9 analysts following the shares rate them a “hold” or worse. Meanwhile, short interest accounts for more than 16% of the stock’s total float. However, the number of AN shares sold short dropped by approximately 11% during the most recent reporting period. A continuation of this trend could provide the security with added buying pressure – a development that would not bode well for either of the aforementioned trading strategies.
The Verdict?
Personally, I’m not putting much stock in a short-covering rally for AN. With technical resistance building in the 10 region, and the stock’s 10-month moving average descending into the area, the path of least resistance remains to the downside. In fact, looking at AN’s long-term outlook, I would expect to see short sellers return to the security in short order. Finally, given the extreme degree of volatility in the market, I would be loath to suggest a calendar spread strategy.
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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.