Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Buy Square's Options Before Earnings

Square, Inc. (SQ) enables payment processing, and also offers financial and marketing services. The Company provides sellers various tools to start, run, manage and grow their businesses. It serves sellers of all sizes, ranging from a single vendor at a farmers' market to multinational businesses. It serves as a payment service provider, acting as the touch point for the seller to the rest of the payment chain. It is reporting earnings on Wednesday, August 3, after market close:

(Source: TD Waterhouse)

As evident from the above, the company beat earnings estimates in 0% of time in the last two quarters, underperforming in 100% of time,and has seen substantial volatility in the market price of its stock over the last three months:

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

On the other hand, market data show that the August options are relatively inexpensive:

(Source: TD Waterhouse)

The three-week straddles (options with a strike price of $11.00) are worth around 14.0% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 16.7% over the last 52 weeks, while the straddle expiring in a bit less than three weeks has an implied monthly volatility of around 12.6% (calculated based on 12 business days remaining until expiration), also including volatility from the earnings event this week. I therefore see signs of modest overvaluation in these options. However, selling the straddle is a good idea given the fact the it encompasses the earnings event today.

Investors can also be interested in buying out-of-money options to partially fund the trade:

(Source: optionsprofitcalculator.com)

On the one hand, this will limit expected returns. On the other hand, this action will minimize losses in the event the stock does not move swiftly over the next three weeks. The risk-return profile of this trade looks like this:

(Source: optionsprofitcalculator.com)

What do you think of this trade?