Quicksilver Ahead of Earnings

By my count, there are 29 optionable companies set to report quarterly earnings during next week's holiday-shortened week. After breaking down the list, I have determined that a very good-looking earnings-based play is retailer Quicksilver (ZQK: sentiment, chart, options) , which is set to report on Thursday, September 8.

According to Hoover's, ZQK caters to the young and athletic with surfwear, snowboardwear, and sportswear sold under brands Quiksilver, Raisins, and Roxy. The firm sells its products in surf, specialty, and department stores worldwide. It also owns 170 of its own stores, including Boardriders Clubs (stores showcasing board sports), Roxy (junior apparel stores), and Hawk Clothing (stores featuring products named for famed boarder Tony Hawk).

With oil soaring more and more everyday, numerous specialty retailers have really taken a pounding as consumers are forced to cut back on their spending. One look at the Retail HLDRs (RTH: sentiment, chart, options) since August gives you a pretty good idea of what I mean.

Also check out what has happened to former high-flyers Urban Outfitters (URBN: sentiment, chart, options) and Bebe Stores (BEBE: sentiment, chart, options) . When you see the former market leaders do something like this, it's a major sign that the rest of the group could be in trouble.

So we have a fundamental reason to be very wary of a retailer in the current environment, but what about the other things that we like to look at before pulling the trigger on a trade?

First off, as you might have expected, the recent price action hasn't been much to get very excited about, with the shares sinking nearly 10 percent since August. But technically, what really has my eyes is $15.50 level. As you can see on the daily chart, this level held as support in June and July, but as of Wednesday it served as resistance. This is picture perfect, as old support serves as new resistance. Also helping send the shares lower is the stock's the downward sloping 20-day moving average.

Another thing I like about this one is that the shares received an upgrade on Wednesday from a major brokerage house. Now this might sound a little strange to see this as a positive, but one thing that we've noticed here on the trading floor regarding these specialty retailers is that a few of them over the past three weeks have received upgrades in front of disastrous earnings. Of course this time might be completely different, but the recent trend has been to fade the brokerage upgrades.

Now let's take a look at some of the quantitative sentiment indicators we follow to get a better gauge of the overall picture. The equity's Schaeffer's put/call open interest ratio (SOIR) checks in at 0.29, lower than 86 percent of all readings over the past year. This suggests short-term options players are buying more bullish calls than bearish puts in front of earnings. Remember these short-term speculators are usually wrong, so for that reason we want to go opposite the crowd and look at buying bearish puts.

Also the analysts are bullish, as there are currently eight "buys," five "holds," and no "sells" ratings on the stock. Yes, the shares have managed to gain two percent this year and another 40 percent the past 12 months, so some of this optimism is probably justified. But I'm looking at the probability that ZQK follows other specialty retailers and disappoints in the earnings confessional. Should this happen, there would be plenty of room for downgrades from the analyst community in that case.

Another area I like to look at is what the short sellers are doing. Currently they are piling on, as it would take nearly seven days for all of them to cover their bearish bets. Now I'll admit we do like to see a lot of shorts betting against a company, because should the company report positive earnings, then all of those bearish shorts now represent potential buying power, as they are forced to cover (buy back) their bearish bets. But it can also work the other way. You see, should ZQK announce negative earnings next week, the shorts can act like sharks smelling blood and they'll continue to pile on their bearish bets, thus pushing the shares lower.

Add it all up and ZQK sports a Schaeffer's Equity Scorecard of only 3.5 out of 10.0, which suggests that the stock's path of least resistance is to the south.

In conclusion, although this is a slightly more risky earnings play, I feel that the odds are in favor of a downside reaction next week.

Leaping in ahead of the company's earning report is not for the weak of heart. For those with a more squeamish stomach when it comes to the sometimes mysterious world of options, buying a stock near an earnings announcement can be also be a nice way to increase the returns in your portfolio. A perfect example of this type of situation is represented by a stock play that we recommended back on May 12. At that time, Urban Outfitters (URBN: sentiment, chart, options) had just reported a stellar first-quarter profit of 32 cents per share, besting the Street by two cents per share. On this news, we recommended purchasing URBN in our Schaeffer's Hot Stocks alert service. Now, say you had purchased a front-month call option ahead of this event, only to watch the stock finish relatively flat on the day, and slip lower the following session. While URBN went on to rally more than 14 percent by options expiration just eight days later, those of the weak of heart or unfamiliar with options could have been shaken out of their positions (and a rather tidy profit if you played the right strike) after such a reaction to a seemingly positive earnings announcement.

By purchasing the stock in this situation, subscribers to Schaeffer's Hot Stocks were eventually able to log a profit of more than 17 percent in just two months. And while this is far from the potential returns or leverage gained from trading options, at least your bottle of Tums is still full and resting safely in your medicine cabinet and your pillow doesn't look like the dog just ripped it to shreds.