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

Buy Allergan's Options Before Earnings On Monday Open

Allergan, Inc. (AGN) is a global pharmaceutical company focused on eye care, neurosciences, medical dermatology, medical aesthetics, breast enhancement, obesity intervention and urologics. It is reporting earnings on Monday, August 8, before market open:

(Source: TD Waterhouse)

As evident from the above, the company beat earnings estimates in 100% of time in the last two quarters 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)

Market data show that the August options are relatively inexpensive:

(Source: TD Waterhouse)

The three-week straddles (options with a strike price of $252.50) are worth around 5.2% 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 10.7% over the last 52 weeks, while the straddle expiring in a bit less than three weeks has an implied monthly volatility of around 7.7% (calculated based on 11 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 straddles is a good idea from a theoretical standpoint.

Investors may be interested in selling 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 two weeks. The risk-return profile of this trade looks like this:

(Source: optionsprofitcalculator.com)

What do you think of this trade?