Name That Trade – $ADBE: Install Now, Remind Me Later, Don’t Install

by Enis June 17, 2014 11:31 am • Commentary

ADBE reports earnings after the close today.  We posted an earnings preview yesterday. ADBE was one of the momentum stocks hit by selling in March and April, but the stock remained above its 200 day moving average throughout the correction.  Since its early May low, ADBE has rallied to within 5% of its all-time high of $71.11 set in late February:

ADBE daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
ADBE daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

Yesterday’s move to a 2 month high in ADBE occurred on the stock’s highest volume in the past month, both positive technical developments ahead of today’s earnings report.

I laid out my view on ADBE in yesterday’s preview:

We have focused more on the technical situation when trading ADBE over the past year, since the fundamentals have seemed like a side note in the stock’s very strong uptrend of the past couple years.

The current technical situation suggests continued rangebound price action between $60 and $70.  ADBE’s last earnings report was met with selling for the first time in 6 quarters, and that was a key sign in the stock’s shift from an uptrend to a range trading situation.  If we do execute a trade in ADBE ahead of tomorrow’s earnings report, it will be with a rangebound view in mind.

However, since ADBE is now only 5% away from a new all-time high, and we have seen overall strength in the momentum names over the past week, we have decided not to execute a rangebound trade for earnings in ADBE.  We might look to put on a rangebound trade after earnings if the stock remains in the range and sets up well, similar to what we executed in March.

For those interested in the structure we considered, here was the trade we were looking at ahead of earnings:

Hypothetical Trade:  Buy to open ADBE ($67.75) Jul19th 70/65/60 Put Butterfly for $1.40

– Buy 1 Jul19th 70 put for 3.80

– Sell 2 Jul19th 65 puts at 1.40 each, or 2.80 total

– Buy 1 Jul19th 60 put for 0.40

This structure’s main risk is if ADBE breaks out above $71 after earnings tomorrow, in which case the put butterfly would be out-of-the-money, with less than 1 month to expiry.  ADBE would have to sell off below $60 before the put fly is at risk on the downside, so the higher likelihood risk is to the upside.  We still view the trade as attractive risk/reward, but would have preferred to put it on if ADBE was closer to $66 ahead of the earnings report.

We also wanted to lay out a trade for those who would prefer to play for a breakout in ADBE, since we received the following question:

Can you construct a trade around ADBE earnings where if the stock moves more than 3% either direction you can make money and will lose if the stock stays within the 3% range?

Unfortunately, since the implied move is around 5.25% in ADBE, it’s hard to set up a trade that will make much money on a greater-than-3% move in either direction.  Even buying the weekly 67.5 straddle and selling the weekly 65/70 strangle costs around $2.00, so you can only make $0.50 if ADBE closes above 70 or below 65 on Friday, while risking $2.00 of premium.

If your thesis is to play for a 3 to 7% move in ADBE in either direction (rather than simply a 3%+ move), then the following structure makes sense:

Hypothetical Trade:  Buy to open ADBE ($67.75) June/July 65/70 strangle calendar for $1.15

– Sell 1 Jun21st 65 put at 0.85

– Buy 1 Jun21st 70 call at 1.15

-Buy 1 Jul19th 65 put for 1.40

-Buy 1 Jul19th 70 call for 1.75

This trade structure essentially buys the June/July 65 put calendar and the June/July 70 call calendar, anticipating a move to near 65 or 70.  Too big of a move however, and the structure will end up losing value.  That’s the main risk, as too small of a move will still leave ADBE within 5% of either strike.

This structure is selling 70 vol in June (albeit expiring in a few days) and buying vol in July for around 33. That July vol is likely to come in significantly but that is absorbed in large part by the fact that all extrinsic premium in June will go to zero this week.

Option markets are somewhat wide in ADBE compared to other names, so if you decide to pull the trigger on any of these structures, make sure to use a reasonable limit order so that you do not pay the full bid/ask.