Verizon Communications (NYSE:VZ) Sentiment is Mixed Before Earnings

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Last week, a number of financial pundits offered their revised opinions on Verizon Wireless VZ and the message was decidedly mixed.  On one hand, Sanford Bernstein downgraded its rating to underperform from market perform.  The covering analyst noted that shares have run sharply higher since September 1, gaining about 12%. The firm feels this growth may be unsustainable and even worries that the company faces a challenging dividend environment.

On the other hand, Ji m Cramer made bullish remarks on his Mad Money program and Argus upped its rating to buy from hold. Argus did provide a caveat, however, that failure to synch up with Apple AAPL could mean a negative surprise for the communications giant.

All of this activity is taking shape shortly before VZ reports earnings this Friday morning.  Analysts are expecting per-share results of 54 cents, which is an 11% slide lower from a year ago.  The company has been fairly consistent in its earnings results, matching expectations in five of the last eight reporting periods and exceeding estimates three times.

Whether you are a bull who sides with Cramer and Argus or a more cautious type with earnings approaching, there may be an options strategy that provides an investing alternative to owning or shorting the stock outright.  We've outlined a pair of option strategies below for educational purposes only.  All prices are as of midday Monday, when VZ shares were trading at $32.66, up 23 cents on the day.

Neutral/Volatile Option Strategy: Long Strangle

Investors who think VZ could make a post-earnings move but are unsure of whether this move will be higher or lower may consider a long strangle strategy.  The November 32/33 strangle can be traded for a net debit of $1.10 (buying the November 32 put and the November 33 call, both of which are slightly out-of-the-money).

The investor has this $1.10 debit at risk if VZ is trading between the strike prices when November options expire. Above the breakeven level of $34.10, however, gains are theoretically unlimited if VZ rallies. And if VZ declines, the strangle gains in value below the $30.90 level and all the way down to zero, capped at $30.90.

The strangle strategy is unlike anything in the stock-trading world, because the strangle buyer doesn't worry about direction of a stock's move, only about volatility (or the magnitude of the move).  This chart was created with the profit/loss calculator tool in my virtual trading account.

Bullish Option Strategy:  Cash-Secured Short Put

Investors who believe VZ will hold steady through earnings and for the next several weeks could sell a short-term put.  The November 32-strike put, for example, can be sold for a credit of 49 cents per contract. At expiration, if this put is still out-of-the-money (i.e., VZ is trading above $32), the put expires worthless and the put seller keeps the entire credit as profit.  If VZ is trading anywhere above $31.51 (strike price minus credit), the short put is profitable.

The downside to the cash-secured put is the obligation to buy the shares if the put finishes in-the-money.  If VZ is trading below the strike at expiration and the trader hasn't exited the short put, he will probably be assigned and required to buy 100 shares of VZ (at an effective price of $31.51) for every contract sold.  To avoid margin at all, traders could set aside $3,151 in cash for each put sold.

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Maximum risk is therefore the same as long stock, which is unlimited down to zero. The premium collected as a percent of the cash needed to be set aside is equal to about 1.6%.

Photo Credit: Dan Perry

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