Trading Tools to Build Your Portfolio: Straddling salesforce.com, inc. (CRM) Ahead of Earnings

Will the software concern extend its streak of earnings surprises?

by Andrea Kramer (akramer@sir-inc.com) 11/6/2009 2:15 PM

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In last week's edition of Trading Tools, we analyzed insurance issue MBIA Inc. (MBI), thanks to a flood of front-month call volume highlighted by the Schaeffer's Most Active Options filter. Utilizing the same stock screener for today's column, a different security caught my eye: San Francisco-based software concern salesforce.com, inc. (CRM), which was a popular item in the options pits on Thursday.

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For an explanation of the contrarian stance that makes Schaeffer's so unique, check out a recent version of Trading Tools.

Betting on a post-earnings price swing

On Thursday, CRM saw about 5,300 puts and 7,200 calls change hands, more than doubling its average single-session volume of roughly 2,200 puts and 3,400 calls. The at-the-money November 60 strike garnered the most attention from both sides of the Street, with close to 3,400 puts and 3,000 calls crossing the tape. However, further research reveals that a healthy portion of the 60-strike activity was related.

At 1:17 p.m. Eastern, a block of 500 November 60 puts and an equal amount of November 60 calls traded for $3.05 and $3.35, respectively. Both blocks were marked "spread," and all of the contracts crossed the tape at the ask price, suggesting they were bought. As such, it seems we've unraveled the makings of a long straddle, which makes money in the wake of a significant price swing from CRM in the near term.

The straddle strategist is likely trying to profit from a post-earnings move by the stock, as the company is expected to report earnings after the closing bell on Tuesday, Nov. 17, according to Thomson Reuters. From an historical perspective, salesforce.com has exceeded the Street's per-share earnings predictions in each of the last four quarters. However, instead of simply buying a lone call in hopes of another pleasant profit surprise, the aforementioned trader is hedging his or her bets by initiating a straddle, which generates capital from a monumental move in either direction.

The nuts and bolts

Delving deeper into this volatility play, the 60-strike straddle on CRM was initiated for a net debit of $6.40 ($3.05 + $3.35), which represents the most the investor can possibly lose. In order to make money, the straddle strategist needs the equity to violate one of two breakeven rails by options expiration: $53.60 (strike � net debit) or $66.40 (strike + net debit).

Should salesforce.com snap its winning streak in the earnings confessional, a move beyond the lower breakeven rail could generate substantial profit. However, the strategist's maximum possible reward is capped at $53.60 (strike � net debit), since the furthest CRM could fall is to zero. On the flip side, another quarterly report in the "win" column could power the shares past the upper breakeven level. In this instance, the trader's profit potential is theoretically unlimited, as there's no ceiling to how high CRM could climb.

On the charts

Technically speaking, the shares of CRM have been on fire in 2009, advancing 89.4% since the start of the year. In fact, the stock has been a broad-market standout lately, outpacing the S&P 500 Index (SPX) by 20% during just the past 60 trading sessions. Supporting the equity have been its 10-week and 20-week moving averages, which have guided CRM higher since March.

However, this double dose of trendline support could actually act as a hindrance to the aforementioned straddle strategist, as they could contain any post-earnings pullbacks. Furthermore, the investor's hopes for a monumental move to the upside could be hampered by the overhead $64-to-$66 region, which played the part of support and resistance during most of 2008.

Weekly chart of CRM since January 2009 with 10-week and 20-week moving averages

However, a stronger-than-anticipated earnings report could spook the skeptics, which could lend buying pressure to any potential rallies. Most notably, short interest on the equity increased by 11.5% during just the past two weeks, and now accounts for 10.3 million CRM shares, or 9.5% of the stock's total available float. A pleasant earnings surprise could spark a short-squeeze situation, which, at the security's average daily trading volume, would take close to seven sessions to unwind.

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Trading Tools to Build Your Portfolio: Straddling salesforce.com, inc. (CRM) Ahead of Earnings

Will the software concern extend its streak of earnings surprises?

by Andrea Kramer (akramer@sir-inc.com) 11/6/2009 2:15 PM

CRM

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