Options Update: Fiserv Targeted by a Credit-Spread Ahead of Earnings

With the company’s earnings report just hours away, Fiserv
has seem some rather unusual options activity leading up to the event. For the record, the company is expected to earn 83 cents per share, up 15% from the same quarter last year. Historically, FISV has bested expectations in 3 of the past 4 reporting periods by an average of 1.23%.

Returning to the options activity, more than 6,000 puts have traded on FISV so far today. This volume has outpaced the stock’s average daily put volume by a factor of 11 and placed the equity on today’s Intraday Volume Explosion List. However, it was the interesting activity at the November 30 and November 25 puts that caught my eye today.

Fiserv option volume details

Anatomy of a Fiserv Credit Spread

Digging into the activity, I discovered that 2 large blocks of 3,000 contracts traded on both the November 30 put (FQV WF) and the November 25 put (FQV WE) at about 10:56 a.m. Eastern time on the American Exchange (AMEX). The FQV WE contracts changed hands at the ask price of $0.80, while the FQV WF contracts traded at the bid price of $2.35. With the blocks trading at the same time on the same exchange, I can reasonably assume that these trades are related. In fact, it would appear that we are looking at a neutral-to-bullish credit spread on FISV.

A bullish credit spread involves selling an out-of-the-money put and purchasing a deeper out-of-the-money put. This results in a net credit to the investor’s account. The maximum profit is achieved as long as the sold put stays out of the money by expiration. In today’s example, the trader needs FISV to stay above the 30 level by the close of trading on November 21, when these options expire.

So, how does today’s example work on paper? First, the trader purchases the FQV WE puts for a debit of $240,000 — ($0.80*100)*3,000 = $240,000. Next, the trader sells the FQV WF puts for a credit of $705,000 — ($2.35*100)*3,000 = $705,000. A total credit of $465,000 for the position is arrived at by subtracting the debit incurred by purchasing the November 25 puts from the credit received by selling the November 30 puts — ($705,000 – $240,000 = $465,000).

Hedging Your Bets

So, why not just sell the November 30 puts outright and collect the entire $705,000 premium? Well, the purchased November 25 puts act as a form of insurance against an unexpected plunge in the position. Assuming the trader doesn’t get exercised prior to expiration, FISV can slip to $28.45 per share before the position incurs a loss. We arrive at this by figure by subtracting the difference between the FQV WE and FQV WF puts from the sold 30 strike — [30 – ($2.35 – $0.80)]. Once the shares breach the 28.45 level, the sold November 30 put becomes a liability, and continues to lose money until the shares breach the purchased 25 put. The maximum loss at this point is limited to the difference between breakeven and the purchased 25 put, or $1,035,000 for this position — (1.55 * 100)*3,000 = $1,035,000.

Minus the purchased 25 put, losses increase for every additional point in the money the sold 30 put gains. For example, if FISV falls to $24 per share, losses on the sold 30 put balloon to $1,800,000 — (6.00 * 100)*3,000 = $1,800,000. However with the purchased 25 put now 1 point in the money, it off sets the additional loss in the sold 30 put, limiting the total loss to the maximum $1,035,000.

So, by entering this position the trader needs FISV to hold above the 30 level by the close of trading on November 21. Let’s see if the stock’s technical picture or sentiment backdrop offers up any clues on the potential for the shares to hold their ground.

Getting Technical

Technically speaking, FISV has been in decline mode since mid-September, falling steadily under resistance at its 10-day and 20-day moving averages. Yesterday, the shares tagged an annual low of $28.57 per share, closing just below the 29 level. Today, however, FISV has rebounded more than 8%, reclaiming potential support at the round-number 30 level. While there is concern for bullish traders that the 10-day trendline could limit any upside following a positive earnings report, today’s credit-spread example holds no such bullish aspirations. In fact, as long as the 30 region holds at short-term technical support, a sold November 30 put will remain out of the money.

Daily chart of Fiserv since September 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

The sentiment front offers a mixed view for FISV. Zacks.com reports that the shares have attracted 7 “buys,” 7 “holds,” and no “sells,” leaving ample room for both upgrades and downgrades. Meanwhile, sentiment among options traders hints that expectations for a positive report could be high among speculators. Specifically, FISV’s Schaeffer’s put/call open interest ratio (SOIR) of 0.62 ranks below 80% of all those taken during the past year. This configuration could pose a problem for the aforementioned credit-spread, as a disappointing earnings report could elicit a much sharper downside move due to the elevated expectations.

Sentiment indicators for Fiserv

The Verdict? Personally, the thought of entering a credit-spread position on FISV ahead of tonight’s earnings report seems extremely risky. There are too many unknown variables that could affect the outcome, not the least of which is the company’s outlook for the coming quarter and the full year. Barring the earnings report, such a trade might look more favorable given the stock’s recent rebound from an annual low. That said, I would be more inclined to purchase a November 30 put on FISV given today’s rally ahead of the earnings report and the heavy optimism among options traders.

If you have any questions or comments, make sure to email me. I will do my best to answer your question or address your concern.

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