Square (SQ) FQ1 Earnings Preview with Overlay for Longs

by Dan May 1, 2018 2:49 pm • Trade Ideas

Square (SQ) will report their fiscal Q1 results tomorrow after the close. The options market is implying about an 8.5% move in either direction which is a tad high of the average of about 8% over the last nine quarters since going public in late 2015. With the stock at $48, the May 4th weekly 48 straddle (the call premium + the put premium) is offered at about $4, if you bought that, and thus the implied move you would need a rally above $52, or a decline below $44 by Friday’s close to make money.

Given the range of the stock YTD, and the massive gains last year (~200%), the implied movement post earnings seems kind of fair. Despite being down nearly 20% from its all-time highs made in March, shares of Square are still up 37% on the year.

The stock is in the middle of a little channel where there is mild technical resistance at $50 and mild support at $45:

As one might expect given the stock’s 450% gains from its post ipo lows, and its unprofitability on a GAAP basis, Wall Street analysts remain mixed on the stock with 17 buy ratings, 13 Holds and 3 Sells with an average 12-month price target very near the stock’s current trading level.

So here is my take, the company trades at ridiculous multiple on an adjusted earnings basis, about 100x 2018 expected eps and 65x 2019 eps despite moderating revenue growth (37% in 2018 and 30% in 2019) off of what is not exactly a very large base ($1 billion in 2017). While many think of the company as a b2c payments solution they are making a strong push to be viewed as a company that basically provides small business ‘services in a box’, has a popular mobile payments app and recently announced its ability to buy and sell bitcoin on it. If some of the excitement in the stock is because of bitcoin, please read my post from late last year here, it should not be trading off of this.

I want to add one more point about the stock’s potential reaction to tomorrow’s earnings. Some of the biggest losers in tech today are company’s who’s outlooks did not live up to expectations, but are still up huge on the year (like SQ).

Shopify (SHOP) a $13 billion market cap company is down 7% today but still up 23% on the year.

Grubhub  (GRUB) an $8 billion market cap company is down 9% today yet still up 28% on the year.

Seagate (STX) a $15 billion market cap company is down 7.5% today and still up 28% on the year.

And lastly, and this is not a reaction to earnings, but a competitive product announcement, shares of Match.com (MTCH) an $11 billion market cap company is down 16% today but still up 25%.

Is Square’s 36% YTD gains next to be chipped away? Well that 8.5% implied move makes long premium directional bets kind of hard, as you need to get a lot of things right to just break-even, direction, magnitude of the move and timing. If the May 4th weekly 48 straddle (vs $48 stock) is offered at $4 then the call or the put would cost $2, and that is the size of the move you would need to break-even. So when considering to take a punt into an earnings event like this in a stock where options premiums are high, you need to have a lot of conviction, in this case if you were to buy the weekly at the money put you would need to be confident that the stock would be down multiples of the premium at risk to justify taking the risk of losing 4.25% of the stock price in two trading days.

If I were a long holder of the stock I might consider collaring some gains, selling an out of the money call to finance the purchase of an out of the money put, giving up some potential upside to ensure some potential downside protection. For instance:

vs 100 shares of SQ long at $48 buy the May 18th regular 44 / 53 collar for even money

-Sell to open 1 May 53 call at 1.10

-Buy to open 1 May 44 put for 1.10

Break-even on May expiration:

Profits of the stock up to 53, the stock is called away at 53 but could always buy back the call to keep the long position in place.

Losses of the stock down to 44, protected below

Rationale: this overlay works well because there is put skew in the options, meaning that the $4 out of the money put is about equal to the $5 out of the money call. When giving up some potential upside for some defined risk downside, that’s a good trade off for even money.