Event: Time Warner (TWX) reports their Q1 results tomorrow before the open. The options market is implying about a 5.75% one day move, which is slightly rich to the 4 qtr average one day post earnings move of about 5.25%. I would add that the stock has declined following the last three earnings report, with the average decline being 6.9%.
Price Action / Technicals: Investors in TWX have had a wilder ride than Jon Snow over the last year. From the stock’s 52 week highs in late July, to its recent 25 week lows in February, shares of TWX had nearly a 40% peak to trough decline. TWX is now up about 15% on the year, up 33% from its Feb lows, but still down about 19% from its 52 week highs.
The recent gains seemed to hit some technical resistance at the late August breakdown level, and the early November highs:[caption id="attachment_63343" align="aligncenter" width="600"] TWX 1yr chart from Bloomberg[/caption]
Taking a 5 year view, the stock still appears to be in a downtrend. Even with the recent high, the stock continues to make a series of lower lows. A failure from here back to the 2014 breakout (just below $70) is a possibility and would be the place to target (or protect against long shares) on the downside:[caption id="attachment_63344" align="aligncenter" width="600"] TWX 5yr chart from Bloomberg[/caption]
Valuation: TWX is cheap if you believe 2016 consensus eps estimates calling for 12% growth, on 5% sales growth, with the stock trading below a market multiple at just below 14x, vs peer Disney at 17x expected 2016 eps.
My View: Yesterday, shares of TWX were downgraded at Pacific Crest, citing valuation relative to expected growth, and the costs associated with growing beyond the tv “ecosystem” while investing in platforms like HBO NOW. Those moves are putting pressure on margins in the near term. It sounds like this analyst is expecting at least one more guide lower. Given the stock’s recent run, the stock could easily be down in-line with the implied move if that were the case. Current consensus eps estimates are calling for a meaningful increase in earnings growth from the first half of 2016 t around 8.5% to the second half of 16.5%.
The implied move of about $4 seems fair, and frankly I would expect the stock to find some resistance at the November highs, just above $78, which is essentially in line with the implied move. On the downside the stock could find some support in and around $70, also in-line with the implied move. I think there is a greater likelihood that the stock would outperform the implied move to the downside, in comparison to the upside.
So what’s the trade?
If you were inclined to play for a move following earning in line with the implied move, back towards $70, a weekly put fly could be the way to play.
Trade: TWX ($74.45) Buy to May 6th weekly 75/70/65 Put Butterfly for 1.35
- Buy to open 1 May 6th weekly 75 put for 2.30
- Sell to open 2 May 6th weekly 70 puts at 55 cents each, or $1.10
- Buy to open 1 May 6th weekly 65 puts for 15 cents
Break-even on May 6th weekly expiration:
Profits: of up to 3.65 between 73.65 and 66.35, with max gain of 3.65 at $70
Losses: up to 1.35 between 75 and 73,65 & between 65 and 66.35, with max loss of 1.35 below 65 or above 75
Rationale: This trade structure is in the money, giving a little breathing room to the upside, while offering very near the money profit participation on the downside. The trade risks less than 2% of the underlying stock price, to possibly make up to close to 2x the premium at risk by this Friday’s close in the even the stock is down in line with the implied move.
For those who think the stock can rally a bit, but finds some resistance in the high $70s, near the implied move, and the prior high from November, call calendars could make sense. Especially for those that think the stock could go on a run higher over the course of the Spring
Trade: TWX ($74.45) Buy to May 6th weekly / June 80 call calendar for 55 cents
- Sell to open 1 May 6th weekly 80 call at 30 cents
- Buy to open 1 June 80 call for 85 cents
Break-Even on May 6th weekly Expiration and rationale:
Profits are maximized at $80 on Friday. If the stock goes lower on earnings this will be a loser but with a lot of time for the stock to then reverse higher. If the stock goes nowhere it is set up decently to be spread in June as a call vertical. This trade targets a move higher, then gives the buyer maneuverability for further gains above that strike if they so wish. The risk is a move lower or a really large move higher (significantly above 80) on earnings itself. The difference in vol being sold and bought covers a lot of the vol crush that will happen after the fact.
Estimates and Forecasts from Bloomberg:
* 1Q adj. EPS est. $1.30 (range $1.12-$1.33)
* 1Q adj. OI est.: $1.88b (range $1.65b-$1.95b)
* 1Q rev. est. $7.29b (range $6.83b-$7.63b)
* 1Q segment. rev. ests. (avg of 4 compiled by Bloomberg)
* Turner: $2.88b
* HBO: $1.47b
* Filmed Entertainment/Warner Bros.: $3.08b
* 2016 adj. EPS $5.34, co. forecast $5.30-$5.40 (Feb. 10)