First off, I want to apologize for not posting last week. Life was really busy and I wasn't able to make the analysis that I usually do. Our last trade was selling a $60 strike put on SOXS. While our initial theory that the semi-conductor industry would lose value was incorrect, the buffer we put between the stock price and the strike of the option we sold was large enough that we still did not get assigned. This just goes to show that risk management is key to maintaining consistently winning trades. With this win, our overall return after 4 weeks is $172.53 or 1.73%. Not too bad considering the market is down about 6% in the same time-frame.
This week, we are going to do our first earnings play. Due to the increased uncertainty with earnings reports, option premiums tend to be higher during a stock's earnings week. The stock that we are targeting this week is CVS. CVS has their Q3 earnings on Wednesday November 2nd. I chose a stock that had its earnings in the middle of the week under the assumption that any stock movement due to earnings would even out somewhat by Friday.
Current estimates for CVS' earnings is an increase in value of $1.99 per share. While the expert consensus is $1.99 gain per share, Earnings Whispers has an estimate of a $2.04 gain per share, this would constitute an additional $.05 over the expert consensus. Typically, if a stock announces earnings per share that are higher than the experts are expecting, the stock will increase in value after this information is released. As such, if Earnings Whispers is correct, then we can expect CVS stock price to increase this week. However, lets compare CVS to two other stocks, Walgreens and Rite Aid, that have already posted Q3 earnings to get a better picture into the industry.
First up is the not so pretty picture of Rite Aid. Over the past few quarters, Rite Aid's Earnings per share have consistently missed already negative expectations. This is not a great sign for the company. Another negative indicator for this company is that it has a negative price to earnings ratio (PE ratio) of -0.3068. This isn't a great sign for our CVS play, but given that Rite Aid has a track record of poor earnings and CVS has a track record of beating already positive earnings estimates, I am not going to take Rite Aid's earnings into account all that much.
The recent earnings of Walgreens is similar to that of CVS. Both companies are in the same industry and have a similar earnings records. Walgreens also beat expert's prediction of Q3 earnings by 3.89% which, if current trends continue between Walgreens and CVS, indicates that CVS should beat earnings estimates as well. It is worth noting that, if Earnings Whisper is correct, then CVS will also beat earnings for Q3 by about 3%.
Now that we have our prediction for CVS' earnings this week, lets get into selecting an option to sell. Of course, we will be selling puts again this week as I believe that the price of CVS will increase from its current value of $94.19. While I feel fairly confident about this trade, I still want to limit the probability of the option I am selling ending the week in the money to no more than 20%. As such, I selected the $88 strike with a price of ~$.41 per share. This option has a probability of being in the money of 16.81% and a delta of -.13. As such, I feel that my risk exposure is reasonable given the high probability of positive growth potential for CVS this week. This trade, when taking the average between the bid and ask is $.415 per share, but to be conservative, we will list this option for sale at $.41 per share. After commission fees, this sale will net us a profit of $40.34 for the week. Not too bad!
I hope you enjoyed this analysis and I will see you here next week! Happy trading!
-Vlad
*This is not financial advice. Every investor should invest in companies and utilize strategies that maximize their financial goals within their personal risk tolerance. Trading options is a risky investment strategy.*
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