Event: Alocoa (AA) reports Q1 results tonight after the close. The options market is implying about a 7% one day post earnings move which is rich to its 4 qtr avg move of about 4.25% and its 10 year avg of about 3.5%.
Last night, the WSJ’s Steve Russolillo previewed the results, with a focus on the company’s upcoming split of their pure play commodity business from their faster growing manufactured goods business:
Price Action / Technicals: AA is down only 2% on the year, after making an epic 60% rally from its 52 week and 7 year lows t $6.14 on January 20th.
Maybe the 10 year chart looks like a wash-out, but will likely take a meaningful break above and hold of the $10 level in the near future:[caption id="attachment_62728" align="aligncenter" width="600"] AA 10 year chart from Bloomberg[/caption]
Why $10? Well, like most technical levels its a little arbitrary, but the stock’s recent consolidation below, above its 200 day moving average (purple) and rising 50 day moving average (blue) could set up for a breakout above recent resistance:[caption id="attachment_62729" align="aligncenter" width="600"] AA 1yr chart from Bloomberg[/caption]
Sentiment: Despite the stock’s recent gains, it remains 31% from its 52 week highs made last May at $14.28 and down nearly 50% from its 5 year highs in 2011. Wall Street analysts remain fairly mixed on the stock with 8 Buy Ratings, 10 Holds and 1 Sell with an average 12 month price target of about $11, or about 13.5% from current levels. Short interest is at a 12% of the float, not far from its 52 week highs.
Implied Volatility Snapshot: despite the stock’s recent consolidation, short dated options prices remain elevated, up more than 100% from their 2015 lows, with 30 day at the money implied volatility (blue below, the price of options) ticking above 30 day realized volatility (white below, how much the stock is moving) for the first time since mid January:[caption id="attachment_62730" align="aligncenter" width="600"] From Bloomberg[/caption]
My View: There are two potential positive catalysts for the stock. Obviously, the impending split, but also for the recent firming in commodity prices as a sign that China will in fact have a soft landing and that commodity prices will bottom prior and that stocks such as AA will rally prior to such confirmation. While AA has clearly been in the eye of the storm as it relates to weakening emerging market demand for industrial commodities over the last few years, I would note that AA’s expected $21 billion in sales in 2016, while down 35% from its all time highs in 2007, and down 16% from its five year highs of $25 billion in 2011, is flat with 2010 levels and possibly showing signs of a trough.
I have no idea whether that is the case, but if the company issues poor results and guidance, and the stock holds it together it may suggest that investors are looking beyond near term fundamental weakness to an easing of pressures in EM and the breakup of the company.
What’s the trade? I lack conviction from a directional perspective at the moment, and am most interested to see how the stock reacts to news, good or bad. Do we see a short squeeze that gets faded? or maybe a sell off that gets bought? But for those of you considering an earnings trades, here is one idea for a long stock alternative:
The stock’s rip from the Jan lows poses a problem for those looking to play for a breakout and just getting int he shares here. But poor sentiment, high short interest, constructive technical set up, future catalysts and expensive options prices could lend themselves to stock alternatives like bullish call spread/ risk reversals. For instance with $8 looking like reasonable technical support.
In lieu of 100 shares of AA
AA ($9.70) Sell the July 8 put to Buy the July 11/13 call spread for even money
- Sell to open 1 July 8 put at .30
- Buy to open 1 July 11 call for .43
- Sell to open 1 July 13 call at .13
Break-evens on July expiration:
Profits: of up to 2.00 between $11 and $13, max profit of $2 above $13.
Losses: put 100 shares of stock at $8 or below and potential losses to zero
Mark to market: there will be gains if the stock goes higher and losses of the stock goes lower between 8 and 11 but the close the stock gets to expiration the less deltas the trade has between those strikes. Right now the trade has about 40 deltas (long)
Rationale – This is a way to participate in upside in the stock (nearly 20% potential) while not having to take the risk of buying the stock here. There is risk below $8 but that is nearly 18% lower and those that are bullish should be willing to own the stock down 18%. Since the higher strike is 11 and the stock is only 9.70 here there is the risk of being right in the stock but not getting the magnitude of the move correct.But it is 40 deltas and will gain mark to market even if the stock is unable to get above $11 in the near term. The July expiration captures two earnings events as well as the company split.