The Weekly Options Report: Markets Are Looking gRIMM?

by Philip on December 8, 2011

in Trading

What seems like our favorite tech company of late, Research In Motion (RIMM), is scheduled to report 3Q financial results next week on Thursday December 15th after the market close. Shares of RIMM have averaged a +/-10% move over its last 8 earnings announcements, with 5 of the reports pushing shares strongly to the downside (see chart below):

RIMM Historical Earnings Volatility

RIMM weekly options

The $64,000 question for options traders this time around is will shares of RIMM exhibit the type of volatility seen in the majority of its most recent earnings related moves? My guess is NO and here is why…

On December 2nd RIMM announced that 3Q results would come in significantly below prior guidance due to lower than expected demand for its Playbook tablet device. RIMM now expects 3Q EPS to come in slightly below the midpoint of its $1.20-$1.40 original guidance and revenue to be slightly lower than previous guidance of $5.3 bln-$5.6 bln.  Shares of RIMM responded by immediately falling 10% on the announcement. This, however, is not the primary reason I believe volatility around RIMM earnings will fail to meet expectations. One needs only look at the company’s 1Q earnings announcement on June 16th of this year which followed a negative pre-announcement and still resulted in a 21% one-day decline in RIMM shares following the official report. Proving that clearly RIMM shares have the potential to move meaningfully in the face of pre-announced results.

What makes this time around more interesting is the price at which RIMM shares are trading relative to the book value of its equity. RIMM continues to trade well below book value, which measured around $19 using last quarter’s balance sheet figures. At $16.33 I remain convinced (until proven otherwise) that downside in RIMM over the near-term is limited. With that being said, upside in RIMM in the absence of a take-out also seems to be limited.

So what options strategy should one consider to express a limited range view of a stock in a short time frame? I’m suggesting long shareholders of RIMM consider selling 15-17.5 weekly strangles in RIMM, taking advantage of heightened volatility in the weekly options due to its forthcoming earnings release and to express a limited price range view of RIMM shares. Using Thursday’s closing prices, traders could collect $0.80 for the 15-17.5 weekly strangle sale, resulting in break-even levels of $14.20 (-13%) on the downside and $18.30 (+12%) on the upside. The short-term duration of the trade severely restricts the time frame for a potential acquisition, which could push shares of RIMM meaningfully higher. A strong move lower would require you to purchase additional shares of RIMM which wouldn’t be all that bad for those that believe the company will eventually be purchased at price higher than current book value.

Chart of the Week (courtesy of TradeMonster)

In this week’s chart we highlight unusual trading activity, more specifically unusual call volume, from Thursday trading. Institutional trading desks typically follow atypical trading flow to both protect and position their portfolios to take advantage of outsized moves. Unusual call volume is sometimes a harbinger for potential M&A activity.

Trademonster Live Action

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