Arcángel de Jesús Montoya
2
All posts from Arcángel de Jesús Montoya
Arcángel de Jesús Montoya in Alexander Valtsev,

Buy P&G's Options Prior To Earnings

The Procter & Gamble Company (PG) provides consumer packaged goods. The Company operates in five segments under GBUs: Beauty, which offers a range of products ranging from deodorants to cosmetics to skin care; Grooming, which includes blades, razors and electronic hair removal devices, such as electric razors and epilators; Health Care, which includes oral care and personal health care products.; Fabric Care and Home Care, which consists of a range of fabric care products, home care products and batteries, and Baby Feminine and Family Care, which offers diapers, pants, baby wipe, Bounty paper, towel and Charmin toilet paper brands. It is reporting earnings on Tuesday, August 2, at market open:

(Source: TD Waterhouse)

As evident from the above, the company beat earnings estimates in 38% of time in the last eight quarters, underperforming or showing in-line results in 62% of time, and has seen modest 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 monthly straddles (options with a strike price of $86.50) are worth around 2.9% 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 4.6% over the last 52 weeks, while the straddle expiring in a bit less than a month has an implied monthly volatility of around 3.8% (calculated based on 14 business days remaining until expiration), also including volatility from the earnings event this week. I therefore see signs of modest undervaluation in these options. Hence, buying the straddle is a good idea from the theoretical standpoint.

Investors can also be interested in selling out-of-money options to partially fund straddles:

(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?