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

A New Way To Look At Urban Outfitters' Earnings Tomorrow

Urban Outfitters, Inc. (URBN) is a lifestyle retail company. The company operates through two business segments: Retail and Wholesale. The Retail segment consists of the company's Urban Outfitters, Anthropologie Group, Free People and Terrain brands, whose merchandise is sold directly to the company's customers through retail stores, Websites, mobile applications, catalogs and customer contact centers. It is reporting earnings on Tuesday, August 16, after market close:

As evident from the above, the company beat earnings estimates in 37% of time in the last eight quarters, underperforming or showing in-line results in the rest of time, and has seen significant 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)

Market data show that the August options are a bit overvalued:

(Source: TD Waterhouse)

The one-week straddles (options with a strike price of $31.50 and expiring on August 19, 2016) are worth around 8.5% 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 11.8% over the last 52 weeks, while the straddle expiring in a bit less than a week has an implied monthly volatility of around 5.1% (calculated based on 4 business days remaining until expiration), also including volatility from the earnings event this week. I therefore see signs of modest overvaluation in these options. Hence, buying the straddles is a good idea from a theoretical standpoint.

Investors may also be interested in selling out-of-money options to finance the purchase of straddles, in the event they believe the stock will move swiftly post-earnings:

(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 week. The risk-return profile of this trade looks like this:

(Source: optionsprofitcalculator.com)

As you can see from the above illustration, the "window of safety" is around 13.4%. This means that the stock has to move roughly 7% in either direction from the current price by expiration in order for investors to break-even. The risk-reward ratio of around 1:0.63 is in line with this type of option strategies.