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Estee Lauder Targeted for a Short Put Spread Ahead of Earnings

However, EL drops on a weaker-than-expected outlook

by 2/3/2012 10:45:55 AM
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Wrapping up a week chock-full of earnings releases, The Estee Lauder Companies Inc. (EL - 57.27) stepped up to the plate ahead of this morning's bell. For the fourth quarter, EL recorded a profit of $396.7 million, or $1.00 per share, a 15% year-over-year rise from $343.9 million, or 86 cents per share. Excluding items, earnings landed at $1.01 per share. Thanks to strong holiday sales, revenue jumped 9.9% to $2.74 billion. The results fell in line with analysts' projections for adjusted earnings of $1.01 per share on $2.75 billion in revenue. For the current quarter, EL is calling for earnings of 28 cents to 32 cents per share -- far short of the 41 cents per share expected by brokerage firms.

Ahead of today's announcement, Wall Street was a bit smitten with the cosmetics concern. For starters, Zacks reports that no fewer than 10 analysts maintain a "strong buy" recommendation toward the stock, compared to six "holds" and one "strong sell." In addition, the average 12-month price target of $67.56 -- as calculated by Thomson Reuters -- represents a relatively modest 15% premium to yesterday's close of $58.85.

Elsewhere, EL's Schaeffer's put/call open interest ratio (SOIR) of 0.97 ranks in the 37th percentile of its annual range, indicating that short-term speculators are more call-heavy than usual toward EL.

Despite this recent preference for calls, one neutral-to-bullish bettor in yesterday's session employed a short put spread in the front-month series. Specifically, this speculator sold two blocks totaling 500 puts at the February 57.50 strike for $1.65, while simultaneously buying two symmetrical blocks of 500 puts at the February 52.50 strike for $0.28 -- resulting in a net credit of $1.37. This trader is expecting EL to remain above $57.50 through February expiration, leaving both legs to expire worthless, and allowing the investor to pocket the full potential profit of $1.37, or the initial credit received.

Price Chart of EL

Thanks to its weaker-than-expected outlook, the optimism toward EL is waning in today's session, with shares of the stock falling 6% right out of the gate. Although the security has pared some of these losses, it is testing its foothold atop the $57 level -- a neighborhood that has alternately served as both support and resistance since November. Should EL continue with today's post-earnings decline, the maximum potential loss for the aforementioned short put spread player will be limited to $3.63 (difference between the strikes - net credit). However, the trader can still come out ahead, as long as EL settles above $56.13 by front-month expiration.

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