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Is Applied Materials (AMAT) primed for a sharp post-earnings move?

Joseph Hargett, Schaeffers Research
0 Comments| August 7, 2009

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The semiconductor sector has come on strong in 2009. In fact, the Semiconductor HOLDRS Trust (NYSE: SMH) has soared more than 43% since the beginning of the year, easily outpacing the S&P 500 Index's (SPX) gain of about 11% for the same time frame. What's more, the trust has gained momentum in the wake of better-than-expected earnings reports from industry leaders Intel Corp. (INTC) and Texas Instruments Inc. (TXN), SMH's No. 1 and No. 2 holdings, respectively.

Despite its impressive performance, Wall Street remains extremely bearish on SMH. For instance, more than half of the 910 ratings on semiconductor stocks are "holds" or worse, according to analyst data from Zacks. Among the most heavily panned SMH holdings among brokerage firms is Applied Materials Inc. (NASDAQ: AMAT). Specifically, the equity has garnered just five "buy" ratings, compared to nine "holds" and two "sells." Furthermore, Thomson Reuters reports that the consensus 12-month price target for AMAT rests at $13.23 per share, a discount to the stock's Monday close at $14.01 per share.

Options traders, however, have taken a considerably more bullish stance. For instance, the security's SOIR of 0.38 indicates that calls nearly triple puts among near-term options. This ratio also falls just 14 percentage points shy of an annual low, underscoring the heavy-handed bullish sentiment among options traders.

Even more impressive is AMAT's 10-day International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) call/put volume ratio of 5.33. Not only does this reading rank above 85% of all those taken during the past year, but it also means that calls bought to open have more than quintupled puts purchased on these exchanges during the prior two weeks.

Looking at the stock's technical performance offers some justification for the bulls in the options pits. AMAT has rallied more than 38% so far in 2009, with the shares enjoying the sector lift provided by INTC's and TXN's recent earnings reports. Along these lines, AMAT has skipped higher along the support of its 10-day and 20-day moving averages since early July. Prior to this upswing, however, AMAT was locked in a trading range between support near $10.50 per share and resistance around $12 per share. The stock is currently battling short-term resistance at the $14 level as the shares await rising support from their 10-day trendline.

Click to enlarge

Fundamentally, AMAT is scheduled to release its quarterly earnings report on Aug. 11. Wall Street is expecting the company to report a loss of eight cents per share, down sharply from last year's profit of 14 cents per share. Traders looking for a better-than-expected release from the company should consider that AMAT has topped Wall Street's estimates only twice during the previous four reporting periods.

With extreme optimism from options players, heavy pessimism from analysts, a key technical hurdle looming overhead, and an earnings report just over the horizon, AMAT could be poised for a sharp move. The problem is picking a direction for this move. Options traders might consider entering a straddle position on the equity, such as an August 14 call/put straddle, as a disappointing report could prompt options traders to bail on their positions, while a positive report could prompt analyst upgrades.

However, the equity's August implied volatility has crept higher recently, making front-month AMAT options quite expensive. Specifically, implieds on the August 14 call arrive at 37%, while implieds on the August 14 put rest at 43%. Comparatively, one-month historical volatility arrives at 32%. While an August 14 straddle entered ahead of AMAT's earnings report could be an excellent way to take advantage of a sharp move in either direction for the equity, options traders are going to pay a bit more for such a position at the moment.

Disclosure: Joseph Hargett has no financial interest in any of the equities or products mentioned in this article.



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