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Here Is An Interesting Trade in NetApp's Options Pre-Earnings

NetApp, Inc. (NTAP) provides software, systems and services to manage and store customer data. The company enables enterprises, service providers, governmental organizations, and partners to envision, deploy and evolve their information technology (IT) environments. The company offers a portfolio of products and services that satisfy a range of customer workloads across different data types and deployment models. Its data management and storage offerings help manage business productivity, performance and profitability, while providing investment protection and asset utilization. It is reporting earnings on Wednesday, August 17, after market close:

As evident from the above, the company beat earnings estimates in 50% of time in the last eight quarters, underperforming or showing in-line results in the rest of time, and has seen modest volatility in the market price of its stock over the last three month:

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

Market data show that the August options are a bit overvalued:

(Source: TD Waterhouse)

The one-week straddles (options with a strike price of $28.50 and expiring on August 19, 2016) are worth around 5.7% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 8.8% over the last 52 weeks, while the straddle expiring in a week has an implied monthly volatility of around 3.3% (calculated based on 3 business days remaining until expiration), also including volatility from the earnings event next week. I therefore see signs of modest overvaluation in these options. Hence, selling the straddles is a good idea from a theoretical standpoint.

Investors may also be interested in doing calendar spreads to capitalize on the above-average implied volatility in the short-term options:


The risk-return profile of this trade looks like this:


As you can see from the above illustration, the "window of safety" is around 15.6%. This means that the stock has to move roughly 8.0% in either direction from the current price by expiration in order for investors to start losing money. The risk-reward ratio of around 1:3 is in line with this type of option strategies and is deemed attractive in this case.

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