Retail giant Wal-Mart Stores, Inc. (WMT) is set to report their most recent quarterly earnings report Tuesday February 21st before the market opens. The stock is currently trading around $68.90 in a 52 week range of $62.35-$75.19. The stock has been underperforming the market over the past year with shares rallying only 4.06% in 12 months. The stock has been even weaker over the past 6 months with shares falling over 5.5% over that period of time. The stock appears to be setting up for a continuation of that move lower ahead of earnings next week. To analyze this setup we will look at the stocks historical movement record on and around earnings day, the current implied move being priced into the options market and the stocks technical setup on the daily chart.
First we will examine the stocks historical earnings performance record. We are most concerned with the performance of the stock on and immediately after earnings day. When analyzing WMT’s historical earnings performance record we can see that shares of WMT have sold off on earnings day 9 of the past 12 quarters with an average move of 3.62% and has also sold off 9 of the past 12 quarters form earnings day to the nearest options expiry with an average move of 3.73%. We can see here that there is a clear bearish bias in WMT price action after earnings. With this in mind we can calculate the expected movement and develop targets we can use in our chart analysis.
To calculate the stocks expected movement on earnings we will use the price of the at the money straddle. The at the money straddle price shows us how much the market makers are expecting the stock to move by expiry. To isolate the earnings event we will use the shortest dated options that still contain the earnings catalyst. In this case we will use the February 24th weekly options. Below is the at the money straddle market for the WMT 69 strike straddle.
We can see here that the mid-market price of the straddle is around $2.40 this tells us that the market makers are expecting a move of 3.48% by options expiry in WMT. Since this is inside the historical average move we know that there is no opportunity to sell premium in WMT. With is expected movement we will calculate upside and downside targets and then examine the stock’s chart.
Upside Target = $68.87 + $2.40 = $71.27
Downside Target = $68.87 – $2.40 = $66.47
We will keep these targets in mind we can analyze the chart in WMT below.
The WMT daily chart shows a clear downtrend in WMT and does nothing to invalidate the bearish bias in historical movement. With a bearish historical movement record and bearish chart we can only justify a short setup in WMT.
Potential Trade: Buying the WMT Feb 24th Weekly 67.5-66.5 Put Spreads for $0.30
Risk: $30 per 1 lot
Reward: $70 per 1 lot
This trade has a great reward to risk ratio and takes into account the historical movement record and the current technical setup in WMT. This is a way traders can get into low risk high reward setups ahead of earnings.
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