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Pre-Earnings Pandora Speculators Bet on Limited Upside

P's December 10-strike call saw a glut of sell-to-open activity on Monday

by 11/27/2012 10:47 AM
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Earnings are on the horizon for Pandora Media Inc (NYSE:P - 8.27), and option players have displayed a growing affection for calls ahead of the announcement. At the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), the stock's 10-day call/put volume ratio has soared to 18.59, from its 50-day call/put volume ratio of 1.76. What's more, this shorter-term ratio is ranked at a 52-week peak, indicating calls have been bought to open over puts at an annual-high clip in recent weeks.

This trend was continued in yesterday's session, with calls easily outpacing puts. Around 23,000 calls crossed the tape, more than double the number of puts that changed hands. The most-active strike on the day was the December 10 call, which saw 12,177 contracts trade. However, the majority of these crossed at the bid price, and open interest surged overnight, hinting at sell-to-open activity.

By initiating these out-of-the-money short calls, traders expect P to remain south of the $10 mark through December expiration. In this scenario, the calls will expire worthless, and the speculators can pocket the initial premium collected, or $0.27 per contract, which Trade-Alert indicated was the volume-weighted average price. However, this could also be part of a covered-call strategy, in which shareholders who may be writing these calls would be required to sell the stock at $10 per share, should P rally north of the sold strike by Dec. 21.

As touched upon, P is slated to take its turn in the earnings confessional after the market closes next Tuesday, Dec. 4. Implied volatility (IV) tends to inflate ahead of scheduled events, and such is the case with P's front-month series of options. Specifically, IV at the December 10-strike call is currently elevated relative to the stock's 20-day historical (realized) volatility (87% vs. 69.3%), making selling premium here a more attractive strategy than buying premium.

Technically, the shares of P have struggled on the charts in 2012, with the stock sitting on a 17.2% year-to-date deficit. The equity has shown some signs of life of late, rebounding nearly 17% since hitting a record low of $7.08 on Nov. 16. This recent rebound may be what has attracted option players to long calls over the last two weeks. Additionally, with short interest accounting for almost a third of P's available float, this activity could represent short sellers picking up hedges on their bearish bets.

However, P has resumed its downward trajectory in today's session, and was last seen roughly 3.6% lower, hovering near the $8.27 mark.


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