$V Bump?

by Dan April 20, 2016 1:55 pm • Commentary• Trade Ideas

Event: Visa (V) reports Q1 results tomorrow after the close. The options market is implying about a 4% one day move which is slightly rich to the 4 qtr avg of 3.75% by shy of last quarter’s 7.5% rally.  

There are few charts in the entire market as (nearly) perfect as Visa’s. The stock is up 23% from its February lows, it never broke its August 24th Flash Crash lows and just yesterday made a new all time high, with rising converging 50 and 200 day moving averages:

[caption id="attachment_62999" align="aligncenter" width="600"]Visa 1yr chart from Bloomberg Visa 1yr chart from Bloomberg[/caption]

And for those who might think that a failure at the prior all time high from November could set up for a double top, a look at the 5 year chart shows the stock’s massive out-performance to the S&P 500 (SPX), up 350% from its 2011 lows vs the SPX up 95%, with a consistent uptrend of a series of higher lows and higher highs. Rarely were new all time highs met with immediate rejection during that time period:

[caption id="attachment_63000" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

Lastly, options prices in V are relatively cheap, with 30 day at the money implied volatility (blue below) at 22%, basically in line with the one year average, despite realized volatility (how much the stock has been moving, white below) nearing 52 week lows.  Short dated options prices look fair to possibly cheap:

[caption id="attachment_63001" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

My View in the Print: Aside from the stock’s tremendous out-performance of late and healthy technical set up, there are few things that give me pause. First, Wall Street analysts remain overwhelmingly positive on the stock, with 31 Buy ratings, 8 Holds and no sells, with an average 12 month price target of $86.77, or about 7% above current levels.  And there is a little thing with the stock’s valuation relative to its expected growth. Earnings have been growing double digits for years, in 2016 earnings growth is expected to moderate from 18% in 2015 to 7% in 2016, yet the stock trades at 29x expected earnings, nearing a post IPO high:

[caption id="attachment_63002" align="aligncenter" width="567"]From Bloomberg From Bloomberg[/caption]

I wouldn’t buy this stock with your money into the print, even in a Bizarro market that seems poised to make a new high. But that’s what’s great about options for those that want to own this (or continue to own it) for a breakout. Prices seem fair enough that you can play for more upside yet define risk in case this report is the big reversal in the stock:

In lieu of 100 shares of V (as as a replacement to an existing 100 shares):

Buy the V (81.35) Weekly April22nd 80/85/90 call fly for 1.75
  • Buy to open 1 April22nd 80 call for 2.30
  • Sell to open 2 April22nd 85 calls at .30 (.60 total)
  • Buy to open 1 April 22nd 90 call for .05

Rationale – The current market actions means we’ll start to see some breakouts to the upside in certain stocks at or near their all time highs. But you of course don’t want to be left holding the one that doesn’t. Defined risk stock alternatives are perfect or for the occasion as they can mimic stock for the breakout, but define the risk to a manageable amount if the stock were to see serious downward pressure on earnings. In this case you are only risking 2% of the underlying to play for a move in line with the implied move to the upside. If you saw the implied move to the downside ($3) or worse, this ill not lose as much as long shares. It’s breakeven to the upside is 81.75 so not a lot is being paid in extrinsic premium for the right to define risk. The major trade-off is that to the upside, a move above 85 means the profits begin to trail off, and a move higher than 88.25 and the trade actually becomes a loser, but that is an unlikely move in magnitude.