Last week's article on

gaming earnings surprises, using Smith Barney's proprietary research, generated a lot of interest. Readers wanted more names and more suggestions on how to play companies with upcoming earnings.

While I still can't share the full list of 78 earnings surprise candidates that the standardized unexpected earnings, or SUE, model generated for this quarter, I can highlight a couple of additional companies with upcoming earnings announcements that I think can offer an attractive risk-reward scenario based on expected earnings using my proprietary option-pricing model. Just kidding about my model: I'm really just looking to buy cheap and sell expensive to create a position with an attractive risk/reward equation. Little is proprietary about this approach.

SUE Takes a Shine to These Names


(TXT) - Get Report

operates in the private aviation business, mainly through its Cessna airplane and Bell helicopter divisions. The company reports earnings on Thursday and is expected to show a profit of 78 cents per share. This would represent a 39% increase over the year-ago period. And the projections for the following quarters and full years through 2007 remain equally upbeat, with an earnings growth rate in the 25% range.

After setting a new high at $80 in early March, the stock has pulled back about 10% as the broad market fell apart somewhat. This slide can be considered a correction rather than the start of a bearish trend. The stock now appears ready to close above important support at $72 per share.

A positive earnings call could quickly propel shares back toward $76-$77. Options remain very cheap at 22% implied volatility, which is basically equal to the stock's 30-day and 60-day historical action. This means you are paying no extra premium in buying options ahead of the company's earnings report. With the stock trading at $72.20, I'd take a look at the May $75 call for 75 cents. If the stock pops, the call price will easily double.

Harman International Industries


reports Thursday as well. Of late, weakness in the automotive division has put a damper on the shares: They have tumbled 35% to $85 in 2005.

The company has a nice history of beating estimates and confounding shorts. While the short ratio as a percentage of float remains low at 2.89, that's still up from last month's reading of 2.19. But with a fairly low average daily trading volume of just under 700,000 shares, and with nearly 90% of the shares held by institutions, fringe short-sellers and daytraders are likely to run for cover on any sign of an improving outlook.

Harman is expected to earn 81 cents per share when it reports. That would be a 17% increase over the year-ago period. This stock has a history of being able to run 20%-30% within a three- to four-day period. Now that it has held support at $85, it could easily reclaim ground above $90 resistance in a matter of days following a positive earnings report. With the stock trading near $85.50, I'd look at buying the May $90/$95 call spread for a net debit of $1.20 per spread.

In addition to questions about the SUE model, I know many readers were lost without the Options Forum last week. To remedy that, I came across an interesting question on theoretical value I'd like to share.

Prices in Theory

Your options articles are both valuable and fun to read. One area that I need to understand more is "theoretical value" of an option. Can you explain how this value is calculated? It seems everyone uses Black-Scholes, but the values can be vastly different depending on which Web site you believe. For example, I just looked at a couple of sites and the IBM (IBM) - Get Report Jan. 6 $80 put is theoretically valued at $7.16, and at $3.96 with IBM trading at $77.13. Thanks,

The large discrepancy between the two prices leads me to believe there is an error somewhere. Different pricing models might lead to slight valuation differentials of, say, 2%-4%, but not the nearly 75% spread this reader encountered.

What's funny is that the best theoretical value seems to be somewhere in between the two prices above, but clearly close to the higher end of the range. With more than eight months remaining until the January 2006 expiration, most near-the-money options would have a reasonable amount of time premium above and beyond the $2.87 intrinsic value in the above example.

Remember, the theoretical value is calculated by using the four known components -- stock price, expiration date, dividends and interest rates -- and the stock's historical volatility for the fifth and final input. The volatility, implied vs. historical, is what usually accounts for the current trading price being above or below the theoretical value.

My suggestion would be to check the inputs and make sure everything is equal when using different calculators, especially the dividend. For example, if you fail to include the fact that IBM pays a quarterly dividend of 18 cents, the January 2006 $80 put has a theoretical value of just $6.20. Including the dividend, that value becomes $6.75. If you combine this with not using the same volatility, forgetting to input the prevailing interest rate or using a model that counts calendar days instead of trading days, you could get some very different prices.

Always make sure you know what tools you are working with. If something is obviously in error, double-check your facts.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to