Options Update: Volume Soars on UAL Corp. After Bearish Brokerage Note

Shares of UAL Corp.
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have dropped more than 3.5% today, outpacing the nearly 2% decline in the major market indices. The equity came under fire earlier this morning, when S&P Equity Research cut its price target on UAUA to $12 per share from $15 per share. The brokerage firm kept its rating on the stock at a “hold.”

In unrelated news, UAL Corp. yesterday said that it would release its fourth-quarter earnings figures ahead of the open on Wednesday, Jan. 21, 2009. Currently, Wall Street is looking for the company to post a quarterly loss of $4.47 per share, widening from last year’s loss of just 47 cents per share in the fourth quarter. Historically, the firm has widely topped these estimates, surpassing analysts’ views in 3 of the past 4 reporting periods by an average of about 16%.

With a target cut from the brokerage bunch and a looming quarterly earnings report to fuel speculation, options traders have flooded both UAUA’s calls and puts in today’s trading. Specifically, put volume is outpacing the stock’s daily average by a ratio of nearly 9 to 1, while call activity has nearly quintupled the equity’s average daily volume. This spike in volume has placed the shares on our Intraday Volume Explosion List. UAUA’s most active contracts on the session are the February 5 put and the February 10 call.

UAL Corp. option volume details

The Anatomy of a UAL Corp. Put Position

Looking over the chart above, you can see that UAUA’s February 10 call activity is all over the place. The majority of the activity has crossed the tape between the bid and the ask price, making deciphering this volume virtually impossible. On the other hand, the stock’s February 5 put activity is a single block of 10,000 contracts, which changed hands at the ask price. In both cases, volume easily exceeds open interest, with only 265 contracts in residence at the February 5 put, and a mere 1,372 contracts open at the February 10 call. Given the uncertainty surrounding the call activity, however, I will be running with a put-buying theme in today’s analysis.

Drilling down on the February 5 put, a block of 10,000 contracts traded at the ask price of $0.20 at 10:04 a.m. Eastern time. The total outlay for this position would be $200,000 — ($0.20 * 100)*10,000 = $200,000. For this trade to reach breakeven, UAUA would need to plunge about 43% to $4.80 per share from the stock’s Wednesday close of $10.27 before the options expire on Feb. 20. The maximum loss on this position is limited to the initial investment of $200,000.

By entering this trade, the investor is indicating that he expects UAUA to basically implode during the next several weeks. The position has started on the right foot, with the shares down more than 3% at last check, but there is still a long way to go before this trade reaches profitability. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

With UAUA sitting on a 52-week decline of more than 70%, the stock’s technical backdrop certainly supports a February 5 put position. After bottoming below $4 per share in late July 2008, the shares entered a sideways trend between support at the 8 level and overhead resistance at the 16 level. This channel has tightened in recent weeks, with support rising to the round-number 10 level and resistance falling to the 12-13.50 area. What’s more, UAUA is once again battling resistance at its recently inverted 10-week and 20-week moving averages. The bearish cross of these intermediate-term trendlines points toward continued losses for the security.

Weekly chart of UAL Corp. since October 2007 with 10-week and 20-week moving averages

Meanwhile, a look at the security’s monthly chart reveals yet another technical hurdle for UAUA. The shares have not closed a month above their declining 10-month moving average since November 2007, and this long-term trendline is now pushing its way into the round-number 10 region. Another rejection at this declining moving average could send UAUA further along its long-term downtrend.

Monthly chart of UAL Corp. since November 2007 with 10-month moving average

The Sentiment Drivers

Despite this poor price action, analysts and investors remain stubbornly optimistic in regard to UAUA. For instance, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.30 ranks below 73% of all those taken during the past year, as call open interest more than triples put open interest among options with less than 3 months until expiration. An unwinding of this bullish sentiment could provide additional selling pressure for UAUA.

Elsewhere, 8 of the 11 analysts following the shares rate them a “buy” or better, according to Zacks. Additionally, Thomson Financial reports that the average 12-month price target for UAUA rests at $29.54 per share – a whopping 195% premium to the stock’s current trading range near $10 per share. Should more analysts follow S&P Equity Research’s lead and cut their targets or downgrade their ratings on the firm, it could increase the downward pressure on the shares.

Sentiment indicators for UAL Corp.

The Verdict?

While a February 5 put has promise as a potentially profitable position, the deep out-of-the-money put is a bit too aggressive for my tastes. Personally, I would be more inclined to go with a February 10 or 12.50 put. The former currently sports an ask of $1.75 and would need a decline of only of 17.5% to reach breakeven before February expiration, while the latter is trading with an ask of $3.40 and would need a decline of only 9% to reach breakeven.

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