Why GM Could Motor Higher
President, Stutland Equities
GM led the market lower on Wednesday, but option activity was bullish, with calls trading nearly double their average daily volume.
Much of the volume was concentrated in the June 35-strike calls, which saw 35,580 contracts traded, 98 percent of which were initiated by the buyers. It appears that one trader bought the bulk of these in a single block trade. The trade went down at an average price of $0.14, when GM was at $27.70. This is a bullish trade that will profit if GM rises by 27 percent over the next 120 days.
Last Thursday, GM reported solid fourth quarter earnings. Revenue rose 3 percent year-over-year to $39.5 billion, and earnings per share rose by 23 percent. But on the other hand, North American operating margins declined by 0.70 percent year over year to 5.8 percent. And GM's European division lost $700 million in the fourth quarter, and $1.8 billion for the year.
The picture is a bit brighter in South America, where GM has a 17 percent market share and made $100 last quarter versus a $225 million loss in the fourth quarter of last year. Going forward, the key will be to bring its European division back to profitability, which GM estimates will occur in two years.
In the meantime, GM also needs to focus on increasing North American margins. Ford has done this and has shown it is possible, which means GM shareholders are likely to continue selling if margins show another decrease next quarter.
(Read More: Ford Adds Jobs, Boosts Engine Production.)
This option trade is a shot that GM shares are oversold and will rebound. Fundamentally, the company is relatively cheap—it has a forward price-to-earnings ratio of 7.6, and it generated $4.3 billion in free cash flow for the year. Technically speaking, the stock has been trading in an upward sloping channel, and is nearing the bottom end of that range. A technical bounce could occur in the $26.00 to $26.50 range, and that would send the stock higher in the near term.
Do I think GM is headed back to $35 and change by June? No, I don't think so, and maybe this option trader doesn't, either. Wednesday's trade could be a someone's attempt to protect a short, or possibly bet on a quick rebound.
I might look to put some cash to work on this stock if I see GM print back above $26.60. But until then, I want to see the stock hold onto this lower range before I decide how to play GM.
Disclosures: None to report.
Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."