Options Update: Put Volume Rises on Best Buy Ahead of Earnings

Leading electronics retailer Best Buy
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is scheduled to release its third-quarter earnings report ahead of the open tomorrow morning.

Currently, analysts are expecting a profit of 26 cents per share, well below last year’s third-quarter profit of 53 cents per share. Historically, Best Buy is a stable performer in the earnings confessional, topping expectations in 3 of the past 4 reporting periods by an average of 7.26%.

Wall Street is weighing in ahead of the quarterly release, with Piper Jaffray upgrading BBY to “buy” from “neutral.” According to the brokerage firm, Best Buy should benefit from the changing landscape in retail consumer electronics. With Circuit City bankrupt “and rapidly losing its relevance within the industry, Best Buy now has not only a market share opportunity but also less competition on pricing which should begin to benefit BBY gross margin,” Piper says.

The rest of the brokerage bunch is hesitant to jump on the BBY bandwagon, however. The stock has attracted only 7 “buys,” compared to 10 “hold” or worse ratings. This bearish configuration leaves the door open for potential upgrades should Best Buy surprise Wall Street with a better-than-expected report or solid earnings guidance.

Sentiment indicators for Best Buy

Shifting Options Sentiment

Options traders are also placing heavy bets on the security heading into tomorrow’s earnings report, though with a much more negative perspective. BBY’s Schaeffer’s put/call open interest ratio (SOIR) has been on the rise recently, jumping from a reading of 0.85 on December 4 to today’s perch at 0.93. Still, this reading ranks below 71% of all those taken during the past year, indicating that the speculative group has been more optimistic toward the shares only 29% of the time in the past 52 weeks.

Data from the International Securities Exchange (ISE) and the Chicago Board Options Exchange (CBOE) supports this rising negativity toward BBY. Specifically, BBY’s ISE/CBOE 10-day put/call ratio ranks above 98% of all those taken during the past year, as puts bought to open outnumber calls bought to open by more than 6 to 1 during the prior 2 weeks. This rising bearish sentiment heading into the company’s earnings report could be a sign that investor expectations are plummeting ahead of the event.

This trend toward BBY put options has taken a twist in today’s trading. Looking at our Intraday Volume Explosion List, I noticed that more than 14,700 BBY puts have changed hands so far, doubling the stock’s average daily put volume. The most active contract is the January 2009 17.50 put, which has seen more than 7,900 contracts trade on open interest of just 7,067. However, it was the fact that nearly all of this volume changed hands at the bid price that caught my eye today, as this potential put-selling activity runs in stark contrast to the swell in put buying reported by the ISE and the CBOE.

The Anatomy of a Best Buy Put Position

Digging into this activity, I noticed that a block of 7,850 contracts changed hands at 9:55 a.m. Eastern time at the bid price of $0.40, suggesting that the options were sold to open. Combining this data with the fact that volume exceeds open interest at this front-month strike, it appears that we are looking at a rather large bet that BBY will hold above the 17.50 level by the time these options expire. Running with the put-selling theme, the total credit received for this trade arrives at $314,000 — ($0.40 * 100)*7,850 = $314,000. Remember that a put-sell trader keeps the premium received on the trade as long as the underlying shares remain above the sold strike through expiration, which, in this case, is January 16, 2009.

Best Buy option volume details

Getting Technical

Technically speaking, BBY has lost more than half of its value in 2008. However, the shares have rebounded nicely from their near-term low of $16.42 in late November. The shares currently enjoy the support of their 10-day and 20-day moving averages. Furthermore, the 10-day trendline has taken up residence in the 23 region – an area that has provided support and resistance for BBY since October. This area could now provide a short-term backstop for the shares should the company’s earnings report fall in line with expectations.

Daily chart of Best Buy since August 2008 with 10-day and 20-day moving averages

The Verdict?

Given the negative sentiment among options traders and Wall Street analysts, it would appear that most of the company’s woes have already been factored into the stock price. As such, a lackluster earnings report from Best Buy should meet with muted selling pressure. On the other hand, a better-than-expected report could surprise many options traders and analysts, creating the potential for upgrades and an unwinding of negativity in the options pits.

That said, a call position on a retail stock in the current market environment carries a heavy degree of risk. This is where selling a deep out-of-the-money put makes quite a bit of sense. With the January 2009 17.50 put residing below several layers of potential technical support, selling this option appears to be a solid bet.

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