Event: Analog Devices (ADI) reports their fiscal Q3 earnings tonight after the close. The options market is implying about a 7% one day move which is more than double the 4 qtr avg of only 3.25%.
Why the elevated implied move? There has been a lot of speculation for months that ADI will be the provider of the component that makes the Force Touch capability possible in the soon to be released iPhone 6S. Apple is currently a 9% customer for ADI (they are used in Watch & Macbook), and some analysts (detailed by Tiernan Ray in his Barron’s online column) feel that a design win for the 6S cycle could add up to $500 million in incremental revenue in the coming year (consensus is calling for $3.3 billion in total sales this year).
So if the company were to guide in a manner than does not signal a design win for the next iPhone, or suggests their core biz is weak or weakening, the stock could give back some of its year to date out-performance (up 5% vs the SOX down 8.7%).
Technicals: The two year chart shows the 60% rally from the October 2014 lows to recent highs, and the stock’s subsequent 15% pullback. The stock now sitting on fairly important support both, short term and long term, and frankly looks like an accident waiting to happen:[caption id="attachment_56211" align="aligncenter" width="600"] ADI 2 year chart from Bloomberg[/caption]
Near term, this congestion below the uptrend, and right above support indicates an inflection point as the stock has clearly broken the uptrend and is resting below its 200 day moving average (purple):[caption id="attachment_56212" align="aligncenter" width="600"] ADI 1yr chart from Bloomberg[/caption]
Valuation: ADI screens as fairly cheap for a semi stock relative to expected growth, which is much higher than most peers. Consensus is calling for 205 earnings and 15% sales growth in 2015, with the stock trading at 20x this year’s expected eps growth.
Volatility Snapshot: 30 day at the money implied vol is at new 52 week highs, well above the levels prior to the last few earnings reports, which highlights the potential controversial nature of the the earnings guidance:[caption id="attachment_56213" align="aligncenter" width="600"] ADI 1yr chart of 30 day at the money implied volatility from Bloomberg[/caption]
Options Open Interest: total options volume is heavily skewed towards calls with a total of 59,000 to 24,00 puts, with 8 of the top 10 strikes of open interest all calls.
Our View: We suspect that no matter what the company prints, the stock sells off, barring a large beat and raise. So here a few ways to play vs stock at $58.40:
Stock Alternative – Buy the Sept 57.5/70 call spread for 2.50
The bullish case for the stock lies in the potential for a meaningful contract from Apple for their iPhones, which could be apparent in their guidance, but not likely until their Q4 results are released in mid November. This trade defines risk in the bullish set-up in case that announcement never comes and the stock breaks down here, while leaving room to participate on a move back to the prior highs near 70. The trade risks 2.50 to potentially make 10 if that run to highs happens.
Fading the implied move – Buy the August 60/57.5/55 put fly for .70
Implied vol is high, reflecting the tenuous nature of the chart as well as the unknown of being included in the next iPhone. The second factor probably doesn’t get resolved on this event and therefore it may make sense to fade the implied move. This targets the strike just below the stock so it is slightly bearish, the alternative to this trade that is slightly bullish is to target the higher strike with the 57.5/60/62.5 call fly in August for .65.
Bearish breakdown play – Buy the August 57.5/52.5 put spread for 1.10
If they don’t put up a beat and raise to guidance the stock is very vulnerable here and could be down below 55. This put spread risks 1.10 with the opportunity to make up to 3.90 with the stock at the lower strike 52.50.