Monsanto MON is always one of my favorite stocks to watch, and I enjoy listening to their earnings conference call even more. Earnings are expected to be announced on June 30. With 15 analysts covering MON, the consensus per-share estimate is $0.80, and the high and low estimates are $0.85 and $0.75, respectively.
Monsanto is a world leader in specialized seed production and was the creator of the glyphosate based herbicide Roundup. This product used to be a rose but appears to have become a thorn in MON’s side, losing market share to cheaper Chinese versions since its patent protection expired. The good news is that the Supreme Court recently lifted a ban on Monsanto’s Genetically Modified Roundup-Resistant Alfalfa seed. The company also announced a three-year, $1 billion share buyback effective July 1, 2010. MON also declared a quarterly dividend of 26.5 cents per share on its common stock. The dividend is payable on July 30, 2010, to shareowners of record on July 9, 2010.
On June 9, MON said they are “working on a revitalized product strategy to bring more choices to farmer customers, offering them the premium opportunity the company’s products create.” With this, they projected mid-teens earnings growth beyond this fiscal year. I’m curious to hear more details on their strategy.
While all of these developments appear promising, the stock has not had such a positive reaction. Since making these announcements, the stock has slipped another 3% lower, down to its current level of about $47.75. Observed 30-day volatility has been on the rise; after hitting a low of 17.7% in mid-April, vol surged to a recent high of 40% and has dropped off a bit in the past week or so to 38% in the at-the-money front month options. Implied volatility ahead of the report has been on the rise, but has not exceeded the historical level. The implied volatility mean of the 25 delta call and put is currently right at 40% (as of Monday morning). A 40% volatility implies a daily standard deviation of about 2.5%.
The volatility similarities and muted behavior (to changes to implied vol) seem to be in line with past observations, as MON tends to move less than 4% around its earnings reports. There have been a few instances when MON has made dramatic moves of 8% or greater, with the last large earnings move (17.9%) on 1/7/09.
From a technical analysis perspective, MON does not show signs of being in a bullish trend. It is trading below its 20-, 50- and 200-day moving averages and has moved lower in nine out of the past 10 days.
Hopefully we will be able to get a read from the company on global seed/food demand as well as demand for other agri-products like fertilizer (potash and others). Obviously, as farmers need to increase production, they may use more expensive, higher-yielding seed and fertilizers.
Monsanto has lost about $22 billion in market cap since its early January highs and one wonders, is this justified? Are investors predicting continued softness in global demand? Statements on the conference call will be closely examined, especially forward-looking estimates as well as specifics on how Monsanto will innovate moving forward.
Options traders have a multitude of ways to play this report. Because earnings are typically an event when unknowns become known, the options markets tend to react by sending implied volatility lower, although is this not always the case.
Because there are still many variables when it comes to the future of Monsanto’s business, some traders may choose to make a less directional bet and increase the probability of success even if that means reducing or limiting potential profits. One of the strategies can accomplish this is a credit ratio put spread. A ratio put spread involves the purchase of one put and the simultaneous sale of two further-from-the-money puts. If this trade is done for a credit, the stock can finish anywhere above the lower breakeven and potentially be profitable. (If done for a debit, there will be risk to the upside as well).
The chart below illustrates an example where the investor has bought one August 45 put for $1.59 and sold two August 42.50 puts for 92 cents each, collecting a net credit of 25 cents. The most this trade can make is $2.75, or the difference in strike prices plus the credit collected. This occurs if the stock expires right at $42.50 (the short strike). The breakeven to the downside is $39.75, or the short strike minus the maximum potential profit. This breakeven is roughly $8 less than the current price.
Maximum loss, in the unlikely event that MON falls all the way to zero (and the investor holds onto the spread) is also $39.75, due to the naked short 42.50 put (one of the short puts is “covered” by the long put). If the stock finishes above the long strike ($45), the max potential profit is the 25-cent credit received. This strategy also expresses a bearish thesis toward volatility. To create your own charts such as the one below, sign up in minutes for a free virtual trading account at OptionsHouse.
Of course, traders who believe that volatility will rise along with MON shares (note that these increases typically don’t happen together) could buy a long call, limiting the risk to the premium paid and providing unlimited upside potential. When trading, we always have to consider all the possible outcomes and look for strategies with the best probability of success, based on several observations.
Photo Credit: dok1
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