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Over the course of the past year, Pandora (NYSE: P) has shown a very clear pattern when it comes to earnings.
In each of the four previous Pandora earnings reports, the company announces earnings and then the next day the stock gaps down. The red arrows on the chart below point out the four previous earnings announcements. Pandora is set to release its first-quarter earnings results Thursday after the market closes.
The four gaps lower and the subsequent selling throughout the day after the earnings were released have resulted in declines of 16.6%, 10.7%, 13.5% and 17.2%. This equates to an average loss of 14.5% on the day following the earnings announcement.
With the stock hovering right around the $17.50 level currently, a 14.5% drop would take the stock down to just under $15. At the time of this writing, the May 17.50 strike puts are trading at $1.25, or $125 per contract. Should the stock keep the pattern of declining the day after earnings – and should the average loss apply – if the stock is trading at $15, the 17.50 strike put will have an intrinsic value of $2.50, or an exact double of the value of the option.
You should keep in mind that buying put options or calls ahead of an earnings report can be a risky proposition, and as such, you should invest accordingly. If you normally invest $10,000 into a stock position and your stop loss is 10%, that means you are only willing to take a loss of $1,000. If this is the case, I would suggest not putting more than $1,000 into an options trade like this one, because should the company produce a positive earnings surprise, the stock could gap higher and potentially render the May 17.50 strike puts worthless.
I would also keep an eye on Pandora during the initial few days after the report. I actually think the stock may have turned the corner after being caught in a downdraft for the last year. If the 50-day moving average were to act as support on any pullback, I would be looking to make a bullish bet on the stock.
Analysts expect the company to lose $0.17 per share, which is slightly worse than the $0.13 loss the company reported for the first quarter of 2014. Looking at the four previous reports, the company has beaten estimates by a penny on three occasions and missed by a penny on one occasion.
The sentiment toward Pandora is mixed, with a slightly bearish skew. The short interest ratio is at 4.8, and the put/call ratio is at 0.72, which is higher than 88% of the readings for the past year. Of the 32 analysts following the stock, 19 have it rated as a “buy.”
With the pattern surrounding earnings reports, the obvious play based on past occurrences is to bet on a gap down. Once the dust settles from the earnings report, I would look to make a longer-term play on the stock. My choice for playing the gap down would be the May $17.50 strike put.
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