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Twitter Alcoa (NYSE: AA) will kick off the first quarter earnings season on Wednesday when it announces first quarter results after the closing bell. Analysts expect the company to report earnings per share of $0.25 for the quarter.
The company has been under selling pressure over the last couple of months, but the stock looks like it is trying to curl higher now. The daily and weekly stochastic readings both just made bullish crossovers.
Despite these indicators pointing to a move higher, the last two times the company has announced earnings, the stock has dropped. The last three earnings reports are marked below with the red arrows.
The sentiment toward Alcoa is mixed. The short interest ratio at 2.0, the put/call ratio is at 0.71 (59th percentile) and the analyst ratings show 12 “buys,” seven “holds” and one “sell.” Those three factors are pretty non-committal from both the bulls and the bears.
The key here is the impending Alcoa earnings report and the action after the report. As you can see on the chart, in the week following each of the earnings reports, the stock has moved at least 10% each time. With neither the chart nor the sentiment suggesting a move in one direction or the other, I would not make a directional play. However, there is a way I think you can make money off the Alcoa earnings report.
What I recommend is a straddle. A straddle is an options trade where you buy both the put and the call at the same strike price and with the same expiration date. Because the earnings are coming out only seven trading days before the April options expire, the premiums are low.
My recommendation is to buy both the April 13.50 strike call and the April 13.50 strike put. At this time, the calls are selling for $0.35 ($35) and the puts are selling for $0.47 ($47), giving you a total of $82 invested in each straddle.
Now, if the stock moves up 10% from the current price of $13.39, it would put the stock at $14.73, and the intrinsic value of the calls would be $1.23. If it moves down 10%, that puts the stock at $12.05 and the intrinsic value of the puts would be $1.45.
If the calls have an intrinsic value of $1.23 come next Friday (April 17), the gain on the straddle would be 50%. That is $1.23 minus the cost of the straddle at $0.82, divided by the cost of the straddle.
($1.23-$0.82)/0.82= 0.5 or 50%
If the puts have an intrinsic value of $1.45 come next Friday, the gain would be 77%.
($1.45-0.82)/0.82= 0.768 or 77%
The key to this trade is that the price of Alcoa has to move above $14.32 or drop below $12.68. If the trade is going to produce a profit, one of those two price levels has to be breached.
If the stock is trading anywhere between $12.68 and $14.32 come expiration day, the trade will produce a loss. The worst possible scenario is that the stock closes right at $13.50, which renders both the puts and the calls worthless and the trade produces a 100% loss.
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