Event: IBM reports their Q1 results after the close. The options market is implying about a 3.7% one day move, which is a bit high of the 4 qtr average move of about 3.4%.
Price Action / Technicals: While the stock has been in a fairly large under-performer over the last year to the S&P500, with today’s 3% gains, it is now besting the broad average on the year, up 3% vs the SPX up 2%.
The stock has spent the better part of the last six months basing between $150 and $165 and just now approaching the prior intra-day highs for 2015. $165 has served as massive near term technical resistance, at the low end of the Q3 earnings gap from last October:[caption id="attachment_52914" align="aligncenter" width="600"] IBM 1yr chart from Bloomberg[/caption]
On a longer term basis, $180, the level the stock broke below in October, should serve as staunch long term technical resistance dating back to mid 2011:[caption id="attachment_52915" align="aligncenter" width="600"] IBM 5yr chart from Bloomberg[/caption]
Sentiment: To say that Wall Street analysts hate IBM would be an understatement with only 5 Buys ratings, 20 Holds and 5 sells with an average 12 month price target of $158, below where the stock currently trades. Short interest is almost 3% of the float.
Options Open Interest: Total open interest in evenly split between puts and calls. The single largest strike of open interest is 8,000 of the Jan16 180 calls, followed by 7,000 of each of the following put strikes in Jan16: 150,160 & 165.
Vol SnapShot: 30 day at the money implied vol is below levels prior to the last two quarters, which makes some sense when you consider the consolidation the stock has been in since its October gap:[caption id="attachment_52916" align="aligncenter" width="600"] IBM 1yr chart of 30 day at the money implied vol from Bloomberg[/caption]
My View: As I described in the MorningWord earlier, IBM is in the category of companies with strong dollar exposure. But as INTC and PM demonstrated last week, these companies can beat low expecations as INTC and PM saw their stocks rally when guidance was not as bad as feared. Expectations are clearly low on IBM, and after the GE restructuring announcement a week ago Friday, I am hard-pressed to think that the c-level suite at IBM is not frantically thinking about how to create a much more nimble company to compete in a computing world whose ground is moving quickly below its feet. The only problem, as we discussed back in October, is that IBM seems to be the sort of company that needs to pay others to di-vest their non-core businesses:
IBM would pay a company owned by the apparent buyer of last resort, the investment arm of Abu Dhabi $1.5 billion over 3 years to take their money losing chip business off their hands and that $IBM would take a pre-tax charge of $4.7 billion, per Bloomberg:
So a little fall house cleaning, basically paying Goodwill to come and take everything in their garage, attic and basement so they they can take a write-off
So shareholders are left with an increasing debt load to finance share buybacks to slow the effect of earnings declines. When the company gave guidance on share repurchases on their Q4 call in January it appeared they were feeling a bit skint as they guided to the lowest levels in 10 years, per Bloomberg:
2015 is expected to be the fourth consecutive year of sales declines, which topped out at $107 billion in 2011, and analysts expect to be $84 billion this year. But there is a ray of light within the sales declines. Gross margins are expected to be 5% higher than they were 5 years ago at 51%, so as the company has been shedding business lines as it has focused on more profitable ones.
Potential Trades: I don’t have a ton of conviction, despite the set up looking pretty interesting. Sentiment is very poor, with expectations very low. But the strength of the dollar in the quarter, coupled with decreased buyback activity could result in a meaningful earnings miss. In this scenario, with little reason to own the stock, aside from dividend yield and valuation, the stock could be right back at $150.
Here are a couple trade ideas depending upon your directional inclination:
Bullish: If I thought the stock could rally following the report I would likely give it a little time to play out. One trade that sticks out to me with the stock around $164 is the June 150 / 170 risk reversal, paying about 85 cents for the structure (selling the June 150 put at 1.25, and buying the June 170 call for 2.10). What I like about this trade is that it risks less than 1/2 of the underlying stock price between the well defined range of $150 and $170, and offers long exposure above the breakout level, while also creating a large buffer down to massive support where you would be put stock on the downside. I find this trade structure as a strong alternative to long stock here.
Bearish: The stock was $160 on Friday afternoon, that seems like the level that if it were to break could open the flood gates down to the prior lows at $150. The April 162.50 puts are 2.10 here and that gives you a breakeven on the earnings move of 160.40. Any move below $160 and the puts are quickly profitable on a 1 to 1 basis to stock.