Pandora: Music to Traders' Ears?
The following post is a Guest Blog by CNBC Contributor Brian Stutland.
Pandora saw heavy option trading volume on Monday after announcing December 2012 listener metrics.
The data came in better than expected, with total listener hours up 54 percent year-over-year. As a total share of radio listening in December 2012, Pandora accounted for 7.19 percent, versus 4.71 percent in December 2011, and active listeners increased 41 percent year-over-year. The stock finished 0.50 percent higher on the news despite modest broad market weakness.
On top of this, Pandora is now integrated into more than 1,000 products, many of which are being displayed in Las Vegas at the Consumer Electronics Show right now. The bullish outlook has one option trader positioning himself to take advantage of the potential upside in the stock by selling 7,500 March 8-strike puts for $0.35 each. (Read More: Mobile Wars: Pandora's Got Frenemies.)
This trade will profit if Pandora remains above $8 through March expiration. If Pandora is below $8, the trader will be "put" the stock—in other words, be forced to buy it—at that price, even if the stock is well below that level.
Therefore, by selling the put, the trader is saying that the stock is a good buy at that level. Having already made that decision, this trader is creating yield (17 percent annualized) while waiting to see if the stock dips down to $8.
The reason that the premium—or the options price—is so expensive is simple: This is a really volatile stock. Pandora moves both up and down six times as much as the S&P 500. Yikes! You better get out the antacid if you want to trade this stock.
Due to Pandora's highly volatile nature, selling puts to build a long stock position is definitely the way to go, because it helps prevent buying tops and getting whipsawed.
From a technical perspective, the $8 level looks like a good point at which to buy the stock. Pandora has been trading inside of a descending channel since September 2011, which currently puts resistance at $10.75, and support at $6.70. By selling the 8-strike put for $0.35, the effective buy price of the stock becomes $7.65. The stock appears to be poised for a breakout from its descending channel, if quarterly earnings are as good as the December data implies.
By selling a put instead of buying the stock at the upper end of the channel, you can profit from a breakout without adding significant volatility to your portfolio. You can also wait for a great level at which to buy the stock.
I stay away from trading some of the high-valuation companies like Pandora for myself and clients, but this is certainly a decent trade structure to consider.
Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."
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