Name That Trade – $MU: Three Ways to Play

by Enis June 23, 2014 1:33 pm • Commentary

Micron reports earnings today after the close.  The options market is implying about a 7.5% move, which would put the stock around $34.25 to the upside or $29.75 to the downside if the stock moved in line with the implied move tomorrow.

Micron has been one of the biggest winners in the chip space over the past couple of years.  We previewed the earnings report on Friday, with the following takeaway:

Our View:  Micron has been one of the best performing technology stocks of the past 18 months, and that’s quite a statement.  Skeptics maintain that Micron’s business remains prone to excessive competition and pricing pressure when margins remain attractive like they have been in the recent past, while bulls point to the changed competitive dynamics and favorable product diversification at Micron.

Technically, the stock’s still in a clear uptrend and innocent until proven guilty.  We don’t plan to trade this name ahead of earnings since the implied move looks reasonably priced and we don’t have an edge on the fundamentals, but our one takeaway would be that options look priced on the low end of what we would expect given the stock’s move over the past couple of years.

With that overall view in mind, we wanted to lay out some trade structures for those with a strong view in Micron.

Protection for Long Stock Holders:

Hypothetical Trade:  Buy to open MU ($31.90) Jul19th 31 Put for $1.12

While we looked at a number of different spread and calendar structures, this trade made the most sense for those interested in protection against a long stock position ahead of the earnings event.  Since 30 day implied volatility remains relatively low compared the norm before earnings, and since MU has rallied so substantially over the past 6 months, an outright put offering full protection below $29.88, at a cost of about 3.5%, is reasonable.

A spread or a calendar, while offsetting the overall cost of the protection, could be ill-advised if MU falls substantially over the next month.  On the flip side, going farther out for protection (October for example), makes protection much more expensive given the large amount of additional time value.

 

Breakout to New Highs for Event:

Hypothetical Trade:  Buy to open MU ($31.85) Oct 35/40 Call Spread for $1.05

-Buy 1 Oct 35 Call for 1.65

-Sell 1 Oct 40 call at 0.60

The out-of-the-money call spread does not break-even until $36.05 in MU on October expiration.  However, buying October options gives you an additional earnings cycle in late September, which would be the next major catalyst after tonight’s report.  Buying shorter-dated options is riskier if MU does not rally substantially on the event, given overall premium levels.  $40 is the high from 2002 for MU.

 

Slight Long Biased Structure

Hypothetical Trade:  Buy to open MU ($31.85) Aug1st / Oct 33 Call Calendar for $1.15

-Sell 1 Aug1st 33 call at $1.22

-Buy 1 Oct 33 call for $2.37

This call calendar also buys October upside, but offsets the cost by selling the same strike of August 1st upside.  This trade makes sense for those who think there is limited upside on today’s event, but don’t anticipate a major selloff at any point in the next 6 weeks.