New Trade $YHOO – Marissa Mayer for President?

by Enis January 28, 2013 3:05 pm • Commentary

With a heavy earnings calendar this week (see Macro Wrap for calendar), we went through many names that report this week looking for attractive risk/reward option structures.

YHOO popped up on our radar for several reasons:  

  1. Its implied move is around 5%, but it has moved more than 5% only 2 times in the last 8 quarters.
  2. The 18.50-19 area is very important technical support, as that was where the stock stalled in both 2010 and 2011, but finally broke out from there in 2012, and has bounced from there before.
  3. Sales and earnings expectations for the stock are relatively low for 2013, with sales expected to only climb 3%, and earnings actually expected to fall 7% year-over-year.
  4. However, while analyst expectations seem low, the stock is up almost 30% in the past 3 months, so traders’ expectations are likely higher.

Here is a 3 year weekly chart, with the support area drawn in red:

YHOO 3 year weekly chart, Courtesy of Bloomberg
YHOO 3 year weekly chart, Courtesy of Bloomberg

Finally, on the fundamental front, we got interested on YHOO from the long side after GS upgraded the stock back in September due to a compelling sum-of-the-parts analysis.  (Read Dan’s initial YHOO trade post.)  In that upgrade report, with the stock at $16, the analyst laid out the following case:

With the first stage of Yahoo’s process of valuing and monetizing its stake in Alibaba now past, the risk of uncertainty around the value, timing, tax implications, and management’s plans for the proceeds is significantly reduced. With $5.84 in cash, $4.03 in Yahoo Japan (after tax), and at least $4.93 remaining in Alibaba ownership, Yahoo and the $0.83 in GAAP EPS we expect it to generate next year is trading at $1.35. The planned return of 85% of the initial monetization round should serve as a catalyst for shareholders finally realizing the value of these parts.

Now that the stock trades above $20, “Yahoo and the $0.83 in GAAP EPS for 2013” is trading around $5, which all of a sudden seems like a realistic valuation, particularly given the poor trends in Yahoo’s underlying businesses.  The sum-of-the-parts story might have a bit more juice left in it, but it seems much less exciting than it did when the stock was 4-5 dollars lower.

Add it all up, and we see a relatively high implied move set against a backdrop of fundamental and technical factors that make a big move down quite unlikely, but a big move higher a bit difficult given the recent run.  We debated several different structures, but settled on the following:

Trade: YHOO ($20.30) Buying Feb1st 19/20/21 Put Fly for $0.27
  • Bought 1 Feb1st 21 Put for $1.05
  • Sold 2 Feb1st 20 Puts at $0.47
  • Bought 1 Feb1st 19 Puts for $0.16
Break-Even on Feb1st Expiration:
  • Profits between 20.73 and 19.27, with max profit of 0.73 when stock at 20
  • Losses of up to 0.27 with stock between 20.73 and 21, and between 19 and 19.27.  Max loss of 0.27 at 19 or below or at 21 or above.


Trade Rationale: Given all of the push/pull factors delineated above, the trade above gives us a good risk/reward profile for a low move on the earnings release.  Unfortunately, I had to chase the trade a bit to get done, so this cost is a few pennies higher than I wanted.  It’s certainly not a gimme trade given the profit range of 19.27 to 20.73, but we’ve put the odds in our favor by selling high earnings implied volatility, and we’ve done it in a manner that does not expose us to outsized risk in the process.  Finally, we chose a name that seems more likely to remain in a range based on its fundamental and technical outlook.  At the end of the day, we’ve tried to stack as many factors in our favor as possible, and decided to pull the trigger as a result.