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Three Ways to Trade Goldman Sachs Ahead of Earnings

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Over-loved Goldman Sachs shares look ripe for a few bearish option plays.

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This morning, we kicked off a lively round of second-quarter bank earnings. On the heels of today's reports from JPMorgan Chase (JPM) and Wells Fargo (WFC), Goldman Sachs Group, Inc. (GS) is among the group of Wall Street titans slated to unveil their profit and revenue figures during next week's trading. Goldman Sachs is rising in step with its sector peers at last look, with the shares roughly 3% higher. However, ahead of Goldman's Tuesday-morning earnings release, the prospects for an upside surprise seem relatively low.

From a technical standpoint, Goldman Sachs is down 27.6% over the past 52 weeks -- significantly lagging the broader equities market. Today's rally is stalling out around the security's 50-day moving average, and Goldman Sachs has also been finding resistance in the $98 area. This region marked the site of a bullish gap back in January, but now seems to be serving as a technical ceiling. And just beyond that is the century level, which could step up to reject any serious advances by Goldman Sachs during the coming weeks.



Meanwhile, the stock's surprisingly optimistic sentiment backdrop raises a few contrarian alarms. The Schaeffer's put/call open interest ratio (or SOIR) for Goldman Sachs currently stands at 0.61, which marks a new annual low for the indicator. In other words, short-term speculators are more call-heavy on the stock now than at any other time during the past year.

Taking a closer look, Goldman Sachs is trading below heavy call open interest at the July 100 and July 105 strikes, which carry a combined total of 30,741 contracts in residence. With the front-month series set to expire at the end of next week, this glut of out-of-the-money calls could act as options-related resistance over the short term.

What's more, very few shorts are betting against Goldman Sachs. Following a 31.4% decline during the most recent reporting period, short interest now accounts for a minimal 1.4% of the equity's float. This leaves Goldman Sachs with very little in the way of sideline cash to support a post-earnings rally -- particularly with the stock already enjoying a halo boost in today's session.

The Trader's Take
So what kinds of strategies should options traders consider ahead of Goldman's quarterly report? Personally, Schaeffer's Senior Equities Analyst Joe Bell is partial to a bear put spread, using the July 95 and 90 put strikes. To build the spread, you would buy to open the 95-strike put, and simultaneously sell to open the July 90 put.

With the July 95 put last asked at $1.07, and the July 90 put last bid at $0.28, this spread would currently cost you $0.79. On a move to $90 or below, the maximum profit on this five-point spread is pegged at $4.21. Based on an initial net debit of $0.79, that's a potential gain of more than 500% on the trade. Meanwhile, the most you stand to lose is your upfront investment of $0.79, which will be realized if Goldman Sachs closes at or above $95 next Friday. Overall, in Bell's view, this strategy is a solid way to "take advantage of pre-earnings premiums, while still giving yourself a lot of leverage."

How to Customize It
Maybe, in light of today's bullish action in banks, you're not quite comfortable taking an all-out bearish stance on GS ahead of earnings. No problem. For traders with commitment issues, Bell also thinks a straddle, using the July 95 strike, could be a viable pre-event trade. In this directionally neutral play, you'd buy the July 95 put for $1.07 and the July 95 call for $3.60. This strategy carries a far steeper net debit and maximum loss of $4.67, but it also allows you to profit from a sharp post-earnings move in either direction.

That said, a modest move higher or lower isn't going to cut it for this trade. Goldman Sachs would need to rally past the upper breakeven at $99.67, or fall below the lower breakeven at $90.33, before you'd start to collect a profit. Conversely, profits would begin to accrue on a move below $94.21 with the bear put spread.

Or maybe you're firmly bearish on Goldman Sachs, but you'd prefer to take a slightly more conservative approach than that out-of-the-money put spread. Instead, you could buy to open an in-the-money put -- the July 100 strike, perhaps, which was last asked at $3.65. This premium represents your maximum potential risk, should Goldman Sachs settle at or above $100 upon July expiration. Meanwhile, you'd only need a move down to $96.35 to hit breakeven, with any further decline simply adding to your bottom line.

This article by Elizabeth Harrow was originally published on Schaeffer's Investment Research.

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