|
Even More Pre-Earnings-Announcement Plays
Case Study of a PEA Play (Salesforce.com): Last week, in two different Terry’s Tips portfolios we gained 24.8% in less than 24 hours with the following trades.
In the week preceding the earnings announcement, several articles were published on Seeking Alpha that panned Salesforce.com (CRM).
A sample, with a quote from each:
What's The Deal With Salesforce.com?
“When viewed from the fundamentals, the current valuation of Salesforce is absurd.”
Something Is Seriously Wrong With Salesforce
“… at this dilutive speed, the Salesforce.com stock is little more than a Ponzi scheme.”
Salesforce Earnings Preview: 7th Consecutive GAAP Loss Expected
“What has occurred at Salesforce in recent years are efforts to maximize insider shareholder wealth with no regard to and to the exclusion of outside shareholders.”
Other articles mentioned the huge amount of insider selling at the company – in the last six months, over $150 million was sold by company insiders, about 8% of their holdings. (Most of the sales occurred in late December, 2012, however, and I concluded that it was largely due to efforts to avoid the capital gains tax increase that was expected to come about in 2013.)
In opposition to all this negativity about the company, we saw indications that the stock might not fall after earnings (as so many other companies have done). There had not been a big run-up in the stock price leading up to the earnings announcement, whisper numbers were not higher than analysts’ expectations, and most important of all, the company had almost a perfect record of having higher stock prices after earnings, even when they missed expectations. For those reasons, when we placed the positions in place, we allowed for more room on the upside than on the downside.
Here are the trades we placed:
February 28, 2013 Trade Alert - Earnings Eagle Portfolio – LIMIT ORDERS
These trades will get us set up for today’s earnings announcement after the close for Salesforce.com. Our break-even range extends to about 7% on the downside and 10% on the upside and we only have one day of price changes to worry about:
BTO 4 CRM Apr-13 155 puts (CRM130420P155)
STO 4 CRM Mar1-13 155 puts (CRM130301P155) for a debit limit of $2.71 (buying a calendar)
BTO 4 CRM Apr-13 160 puts (CRM130420P160)
STO 4 CRM Mar1-13 160 puts (CRM130301P160) for a debit limit of $2.99 (buying a calendar)
BTO 3 CRM Apr-13 165 puts (CRM130420P165)
STO 3 CRM Mar1-13 165 puts (CRM130301P165) for a debit limit of $3.12 (buying a calendar)
BTO 3 CRM Apr-13 175 calls (CRM130420C175)
STO 3 CRM Mar1-13 175 calls (CRM130301C175) for a debit limit of $3.10 (buying a calendar)
BTO 4 CRM Apr-13 180 calls (CRM130420C180)
STO 4 CRM Mar1-13 180 calls (CRM130301C180) for a debit limit of $2.93 (buying a calendar)
BTO 4 CRM Apr-13 185 calls (CRM130420C185)
STO 4 CRM Mar1-13 185 calls (CRM130301C185) for a debit limit of $2.48 (buying a calendar)
These trades were placed with CRM trading about $169. These spreads cost $6365 to place including commissions ($55). Note that the largest numbers of contracts were placed at the upper and lower extreme strike prices, and no spreads at all were at the at-the-money 170 strike. These choices resulted in a relatively flat risk profile graph curve with a little more coverage on the upside than the downside.
There was a huge implied volatility (IV) advantage to our calendar spreads. IV for the Mar1-13 weekly options was 100 compared to 36 for the Apr-13 options. The big question was how much the April options would fall in value once earnings were announced. We estimated that IV would fall by 5, (to 31) after the announcement. With this assumption, the risk profile graph looked like this:
The graph shows that a $1500 - $2000 gain might be expected if the stock made only a minimal change in value after the earnings announcement. We set out to create positions that would result in a gain if the stock rose less than 10% or fell less than 7% after the announcement, and the graph showed that we had that coverage.
What happened, however, was that IV of the April options fell all the way to 27, reducing the amount that we were able to gain on the trades. The stock opened up about $7 higher, at about $176. Here are the trade alerts that we issued and the prices we got for the spreads:
March 1, 2013 Trade Alert - Earnings Eagle Portfolio – LIMIT ORDERS
With the stock higher we will take these spreads off first:
BTC 4 CRM Mar1-13 155 puts (CRM130301P155) for $.03 (no commission)
STC 4 CRM Apr-13 155 puts (CRM130420P155) for $1.70
BTC 4 CRM Mar1-13 160 puts (CRM130301P160) for $.05 (no commission)
STC 4 CRM Apr-13 160 puts (CRM130420P160) for $2.50
March 1, 2013 Trade Alert #2 - Earnings Eagle Portfolio – LIMIT ORDERS
Now we will take this one off:
BTC 3 CRM Mar1-13 165 puts (CRM130301P165) for $.05 (no commission)
STC 3 CRM Apr-13 165 puts (CRM130420P165) for a limit of $2.20
March 1, 2013 Trade Alert #3 - Earnings Eagle Portfolio – LIMIT ORDERS
BTC 3 CRM Mar1-13 175 calls (CRM130301C175)
STC 3 CRM Apr-13 175 calls (CRM130420C175) for a credit limit of $4.80 (selling a calendar)
BTC 4 CRM Mar1-13 180 calls (CRM130301C180)
STC 4 CRM Apr-13 180 calls (CRM130420C180) for a credit limit of $5.75 (selling a calendar)
BTC 4 CRM Mar1-13 185 calls (CRM130301C185)
STC 4 CRM Apr-13 185 calls (CRM130420C185) for a credit limit of $4.90 (selling a calendar)
During the day, the stock moved higher, trading as high as $183.24 ($14 higher than it was when we placed our trades).
When we bought the calendar spreads on Thursday, February 28th, our cost was $6365. This entire amount was really not at risk because the long April options would always have a greater value than the Mar1-13 weekly options that we had sold, and we were planning on exiting all the trades on Friday, March 1 (so there would be no further decay in our long options).
We lost money on three of the six spreads we bought but the gain on the other three spreads was much greater than our losses on the losers. We collected $7985 from selling the spreads and paid $41.25 in commissions for a net receipt of $7943.75 and a gain of $1578.75 after commissions, or 24.8%.
We continue to learn. First, we underestimated how much IV falls after the announcement. Second, our idea that stock fundamentals are not as important as expectations in PEA Plays was reinforced (and historical results after earnings is also important). Third, taking off the spreads furthest away from the stock price early is the best way to go (all these spreads ended the day well below what we sold them for).
----------
Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.
You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?
I look forward to having you on board, and to prospering with you.
Terry
|
