Options Update: Shanda Interactive Entertainment’s Put Volume Soars Ahead of Earnings

Shanghai-based Shanda Interactive Entertainment
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operates online games and related businesses in the People’s Republic of China.

The company specializes in massively multi-player online role-playing games (MMORPGs), including “The Sign,” “Woool,” and “Mir II.” Ahead of the open this morning, SNDA announced that it would release its third-quarter earnings results on December 1. Currently, analysts are expecting earnings of 55 cents per share, up sharply from last year’s profit of 44 cents per share. Historically, SNDA has bested expectations in each of the past 4 reporting periods by an average of 13.45%.

This strong performance in the earnings spotlight has fallen on deaf ears, however, as options speculators have shown a preference for bearishly oriented put options in today’s trading. Specifically, more than 4,000 SNDA puts have changed hands so far, outpacing the stock’s average daily put volume by a ratio of more than 12-to-1. This spike in put activity has also placed the shares on our Intraday Volume Explosion List. However, it was the more than 3,000 contracts that traded at SNDA’s December 20 strike that caught my eye today.

Shanda Interactive Entertainment option volume details

The Anatomy of a Shanda Interactive Entertainment Put Position

Diving into the options data, I noticed that nearly all of the SNDA December 20 put volume traded at the ask price, suggesting that the stock was being targeted by buy-to-open put activity. Running with the put-buying theme, it would appear that a trader purchased 3,041 SNDA December 20 puts at 9:44 a.m. Eastern time for the ask price of $0.85. The total outlay for this position would be $258,485 — ($0.85 * 100)*3,041 = $258,485. For this trade to reach break even, SNDA would need to fall about 15% from the stock’s current trading range near $22.50 per share before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $258,485.

By entering this trade, the investor is indicating that he expects SNDA to fall sharply during the next several weeks. The shares have a good head start, slipping more than 3% so far today, but let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

Technically speaking, SNDA has fallen more than 30% so far this year. The shares have settled into a pattern of lower highs and lower lows, dating back to the stock’s near-term peak of $40.71 per share on October 30, 2007. The equity is currently attempting to hold long-term support at the 22 level – a region that has held pullbacks in the shares since December 2006. However, SNDA is being squeezed into long-term support by its declining 10-week and 20-week moving averages. The former rests at the 25 level, which has held SNDA rallies in check since early November.

Weekly chart of Shanda Interactive Entertainment since November 2007 with 10-week and 20-week moving averages

The Sentiment Drivers

On the sentiment front, SNDA indicators are mixed. On one hand, we have a wealth of bearish sentiment from options traders, as the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.86 ranks just 2 percentage points shy of an annual peak. Furthermore, short sellers are betting heavily against the shares, as more than 17.6% of the stock’s float is sold short. This wealth of bearish sentiment could be shaken loose by a strong third-quarter earnings report, thus scuttling a December 20 put.

On the other hand, Wall Street is decidedly optimistic toward SNDA. According to Zacks.com, 5 of the 7 brokerage firms following the shares rate them a “buy” or better, with nary a “sell” rating to be found. This configuration leaves plenty of room for analysts to express their displeasure with a negative earnings report or poor guidance from the company.

Sentiment indicators for Shanda Interactive Entertainment

The Verdict?

While the sentiment and technical backdrops for SNDA appear primed for an extension of the stock’s long-term decline, a December 20 put is a little aggressive for my tastes. Personally, I would be more inclined to consider a December 25 put, currently trading with an ask price of $3.50. For this trade to reach break even, SNDA only needs to fall about 3.5% to reach break even, and with long-term support at the 22 level threatening to give way, the trade has merit given the looming third-quarter earnings report.

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