Options Update: Dell Swarmed with Calls Following H-P’s Earnings

What’s bad for Hewlett-Packard
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must be good news for rival computer manufacturer Dell
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. At least, that’s where options traders are placing their bets. More than 11,000 bullishly oriented calls have traded on Dell so far today, more than doubling the stock’s average daily call volume. At last check, these optimists appear to be on the wrong side of the trade, as Dell shares have dropped more than 6% following H-P’s poorly received earnings report.

This swell in the popularity of Dell calls has placed the equity on today’s Intraday Volume Explosion List>. What’s more, today’s activity falls in line with options traders’ ravenous appetite for call options. Specifically, the International Securities Exchange and Chicago Board Options Exchange’s 10-day call/put volume ratio of 3.46 indicates that calls bought to open have more than tripled puts bought to open during the prior 2 weeks. Furthermore, this ratio arrives at an annual high, meaning that options traders have not been on a bigger call buying spree during the past year.

Returning to today’s activity, Dell’s March 9 call has received the lion’s share of attention. Some 10,000 of the more than 11,000 calls crossing the tape are centered at this soon-to-be front-month strike. With most of the March 9 volume trading at the ask price, we are most likely looking at the initiation of buy-to-open activity at this strike.

Dell put volume details

The Anatomy of a Dell Call Position

Taking a closer look at the March 9 calls, a block of 1,000 contracts traded at 9:50 a.m. Eastern time at the ask price of $0.42. Assuming that these contracts were bought to open, the total outlay for this position would be $42,000 — ($0.42 * 100)*1,000 = $42,000. For this trade to reach breakeven at expiration on March 20, DELL would need to rally about 3.3% to $9.42 from yesterday’s close at $9.12 per share. The maximum loss for this position is the initial outlay of $42,000.

By entering this trade, the investor is indicating that he expects DELL to bounce back from today’s losses by the time the options expire. Unfortunately, the stock’s decline appears to be gaining momentum, with Dell on a collision course with $8 per share. That said, let’s take a look at the stock’s technical and sentiment backdrops for any drivers that could potentially turn this trade around.

Getting Technical

Technically speaking, DELL has been locked in a steep decline for the past several months, shedding more than 56% since February 2008. The stock’s losses have accelerated in recent weeks, with the security declining 15.5% since the start of 2009. Throughout this time frame, the shares have fought a losing battle with their 10-week and 20-week moving averages – trendlines that DELL has not closed a week above since mid-August 2008.

More importantly, today’s plunge has taken the equity below former support in the 8.50-9 region – home to the stock’s November 2008 lows. DELL is now trading at its lowest level since July 1997, and could be poised to extend those losses if potential short-term support at the 8 level fails to hold.

Weekly chart of Dell since August 2008 with 10-week moving average

The Sentiment Drivers

While there is some bearish sentiment among DELL investors, I would have expected to see more betting against the struggling equity. As mentioned above, options traders are outright bullish on the stock, as DELL’s Schaeffer’s put/call open interest ratio (SOIR) of 0.47 ranks below 98% of all those taken during the past year. Elsewhere, short sellers have largely ignored the security, with roughly 3% of the stock’s float sold short.

There is plenty of pessimism among Wall Street analysts, as 13 of the 24 brokerage firms following DELL rate the shares a “hold” or worse. Still, there is plenty of room for downgrades should the negativity surrounding H-P’s earnings grow to encompass its leading competitor. Naturally, downgrades for DELL at this point could be exceedingly bad for bullish investors.

Sentiment indicators for Dell

One final note for consideration is the fact that Dell is slated to release its own quarterly earnings report after the market closes on Feb. 26. Analysts are currently expecting a profit of 29 cents per share for the No. 2 computer maker, but Dell has a shaky history when it comes to meeting these targets. During the past 4 quarters, the company has matched analyst expectations twice and missed twice.

The Verdict?

Next week’s earnings report could be a boon for Dell bulls, especially in the wake of H-P’s poor reception today. However, Dell may have to do more than simply meet Wall Street’s expectations, given the flood of bullish options traders snatching up calls. Regular readers know that I dislike trading options this close to a known event, but if Dell were to rally into overhead resistance at the 10 level ahead of earnings, then a March 10 put might make a nice earnings-related play on this struggling company.

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