General Mills (GIS - Get Report) stock has a recent history of rallying on better-than-expected earnings, and it's likely to do it again when the company reports results next Wednesday. Investors can use stock options to profit from an earnings rally.
Here is a record of the last four quarterly reports:
On Sept. 22, 2015, the company reported adjusted earnings per share of 79 cents, topping the analyst consensus for 69 cents. That's a 14.5% surprise.
On Dec. 16, 2015, the company reported adjusted EPS of 82 cents, which was a penny shy of analysts' expectations.
On March 23, 2016, General Mills reported adjusted EPS of 65 cents, vs. estimates for 62 cents. It was a 4.8% surprise.
And on June 29, 2016, the company reported adjusted EPS of 66 cents, a 10% surprise over the 60 cents analysts were expecting.
What makes these positive surprises noteworthy is the stock performance right after each of these events. The chart shows the price pattern.
In each instance of a positive earnings surprise, the stock price rose immediately afterward. The one quarter with no positive surprise led to a retreat in price.
A closer look at the six-month chart reveals a strongly bullish reversal signal with confirmation.
The flip from resistance (set in June) to new support (in September) forecasts that the price is not likely to decline further. Coming off a big drop in price from the low $70s to the close on Thursday of $65.54, two strong bullish reversal candlestick signals appeared: a piercing lines signal confirmed by a meeting lines signal. This was further confirmed by momentum. The relative strength index fell from the middle of its range to levels close to the oversold area.
Expect to see a big rally with positive earnings before the open next Wednesday. With this in mind, a good options position to exploit is a synthetic long stock trade. This is a two-part trade that costs very little but mirrors the price movement of stock. Look at the October options (expiring in 35 days). The following positions set up the synthetic long stock trade:
Buy the 65 call at an ask of 1.89. Including trading fees, the total cost is $198
Sell the 65 put at a bid price of 1.69. Including trading fees, the net premium is $160
The net debit = $38
For only $38 you can benefit from a rise in the stock price. As that occurs, the long call option gains value point for point above the strike price, and the short put option loses value. It can be closed at a profit or allowed to expire. If the stock price declines, the net effect is the same as holding 100 shares of stock. In that case, however, the exposed short put can be closed to avoid exercise or rolled forward. The short put option's market risk is the same as the market risk for a covered call.
Given the earnings history for General Mills, a positive surprise and upward surge in price is a reasonable forecast. This options strategy will benefit if that occurs.