Analyzing Alcoa (AA) Options Strategies Ahead of Earnings Reports: Bull Put Spread and a Short Iron Condor
Deutsche Bank downgraded Alcoa Inc. (NYSE: AA) to “hold” from “buy,” this morning, citing higher energy prices and increased costs. Deutsche additionally trimmed its 2011 profit outlook to $1.51 per share from $2.08 and lowered its 12-month price target to $18 from $25 (note that this still represents 24% of upside from current levels). AA closed at $14.70 heading into the holiday weekend and is currently trading at $14.66.
“A series of ‘one-off’ business impacts appear to be dampening Alcoa’s near-term ability to continue capitalizing on higher aluminum prices,” the bank said in an article on MarketWatch.
This downgrade occurs one week before Alcoa unofficially kicks off the next earnings season when it reports after next Monday’s close. Analysts are expecting per-share results of 15 cents. Last quarter, the aluminum company’s earnings results fell short of the consensus view by a nickel and the stock suffered an 11% drop the day after. While this report is a shorter-term driver, it could be symptomatic of Deutsche Bank’s growing concerns.
In the bulls’ corner, providing a solid base in recent weeks is technical support, both from the stock’s 50-day moving average and the 14-level. Additionally, AA’s 40-week moving average has helped guide the stock gradually higher since last June.
Some traders may share Deutsche Bank’s concerns surrounding Alcoa, but others may favor the fundamental backdrop of potentially strong industrial demand (especially from emerging markets). Investors who are bearish, bullish, or neutral on AA can trade the metals name with options. This typically means less capital commitment up front and potentially improved returns thanks to the concept of leverage. On the flip side, many options strategies have more at risk on a percentage basis. For those interested in expressing their view with AA options, two potential strategies are outlined below. These are not buy-sell-hold recommendations, just hypothetical examples of two trades.
Always be sure to do your own research and take your personal risk/reward tolerance into account.
*Option prices given as of Monday morning
Bullish Option Strategy: Bull Put Spread
Investors who think AA will emerge from next week’s earnings relatively unscathed (at least in the intermediate term) could consider selling an in-the-money put spread.
The July 14/12 bull put spread is currently priced around 60 cents (a credit that can be collected from simultaneously selling the 14-strike put and buying the 12-strike put). If AA is still trading above $14 when these options expire on July 16th, the spread trader will keep 100% of this credit collected as profit. At expiration, this trade will make money as long as AA is above $13.40. The maximum loss for this strategy, which occurs if AA declines below $12, is limited to $1.40 (for a potential return on risk of 43%).
Neutral Option Strategy: Short Iron Condor
Investors who agree with Deutsche Bank and have a neutral view of AA stock might sell an iron condor in the July series. By selling both the July 12/11 bull put spread and the July 17/18 bear call spread, an investor can collect a combined credit of $0.32 per condor. If AA is trading between the two short strikes (12 and 17) at expiration, the investor keeps this premium as profit. The maximum loss of $0.68 would occur below 11 or above 18. Breakevens for this condor strategy are $11.68 to the downside and $17.32 to the upside; south or north of these respective levels, the trade will begin to lose money.
Do You Have a Plan for AA?
It’s a week before Alcoa earnings; are you feeling confident, or do you think the stock is poised for a pullback? Let us know how you would consider trading AA in the wake of today’s downgrade.
If you are new to options and still trying to get your feet wet, it’s helpful to start by trying your trades in a virtual trading account.
Photo Credit: hyku
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