Options Update: Call Volume Spikes on Research In Motion Limited Ahead of Earnings

Smartphone guru Research In Motion Limited
Quote |
Chart |
News |
is slated to release its quarterly earnings report after the close tonight.

Analysts are expecting RIMM to post a profit of 80 cents per share, a 23% improvement over the same quarter last year. Historically, the company’s performance in the earnings confessional has begun to slip. During the past 4 reporting periods, RIMM has missed analyst expectations twice and beaten twice. The average upside surprise is about 1.3%.

Heading into the event, options traders are pulling out all the bullish stops. RIMM’s Schaeffer’s put/call open interest ratio (SOIR) of 0.44 indicates that calls more than double puts among near-term options, and ranks below all others taken during the past year. This reading indicates that options traders have not been more bullish toward the shares at any point during the past 52 weeks.

What’s more, data from the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) underscores this excessively bullish investor sentiment. Currently, RIMM’s 10-day ISE/CBOE call/put ratio arrives at 2.67, meaning that calls bought to open have outpaced puts purchased by more than 2 to 1 during the prior 2 weeks. This ratio also arrives at an annual peak, indicating that traders on the ISE and CBOE exchanges have not been more interested in buying RIMM call options at any point during the past year.

The flood of RIMM call options is continuing today, with call volume more than doubling the stock’s daily average. Turning to our Intraday Volume Explosion List, I noticed that the most active contract was the December 40 strike, which has seen more than 40,000 calls change hands so far today.

Research In Motion Limited option volume details

The Anatomy of a Research In Motion Call Position

Digging into this call activity, I noticed that a combined block of 400 contracts changed hands at 9:51 a.m. Eastern time at the ask price of $1.72. The total outlay for this position would be $568,800 — ($1.72 * 100)*400 = $68,800. For this trade to reach breakeven, RIMM would need to rally about 2.6% to $41.75 per share from yesterday’s close at $70.67 before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $68,800.

By entering this trade, the investor is indicating that he expects RIMM to rally sharply before the close of trading tomorrow, likely from a reaction to the company’s quarterly earnings report. The equity has started off on the wrong foot today, however, dropping more than 1.6% at last check. But will the stock reverse course following tonight’s earnings report? Let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

Technically speaking, RIMM is in poor shape. The stock has fallen more than 64% since the beginning of the year, while under performing the S&P 500 Index by about 45% during the prior 60 days. RIMM continues to battle resistance at its falling 10-day and 20-day moving averages, which have pressured the shares steadily lower since mid-August. The latter of these trendlines has taken up residence in the round-number 40 region, and could provide staunch technical resistance in the event of a poorly received quarterly report from company.

Daily chart of Research In Motion since August 2008 with 10-day and 20-day moving average

The Sentiment Drivers

The rest of RIMM’s sentiment backdrop falls in line with the extremely bullish opinions maintained by the options crowd. Specifically, Wall Street has doled out 14 “strong buys,” 3 “buys,” 11 “holds,” and just 1 “sell” rating, according to Zacks.com. Meanwhile, Thomson Financial reports that RIMM’s average 12-month price target resides at $76.82 per share – an 88% premium to the stock’s Wednesday close at $40.67. Any downgrades or price-target cuts due to a lackluster earnings report could send the equity sharply lower.

Sentiment indicators for Research In Motion

The Verdict?

Quarterly reports are always risky, and trading ahead of the event requires a healthy degree of risk tolerance. While I would tend to shy away from jumping into a position ahead of earnings, RIMM’s poor technical performance and heavily bullish sentiment backdrop make it a prime candidate for a potential put position. With expectations for solid earnings apparent among options traders, it could make sense from a contrarian standpoint to take the opposite side of crowd in this situation. A December 40 or 45 put could be profitable, while a January 2009 40 or 45 put would add a bit of a time-premium cushion that could take some of the sting out of a move against the trade.

Newly revised and updated, Bernie Schaeffer’s home study program, “10 Days to Successful Options Trading,” provides a foundation for your options trading success. Includes easy-to-follow guide, CD, DVD, and a special report — Click here to learn more.

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