Option Trade of the Week – Smoking Not

July 26, 2023

We’re a bit heavy on the bullish side of the ledger with our open positions. In fact, we have four open put spreads and one neutral iron condor on the books. So, with earnings season in full swing, I was on the hunt for a post-earnings bearish play. It wasn’t easy, though, as most stocks did well after reporting even though they were obscured by the blinding bearish light of NFLX and TSLA.

The pick for this week is Philip Morris International (PM), the tobacco giant that, according to its website, is “building our future on replacing cigarettes with smoke-free products …” These include heated tobacco, e-vapor and oral smokeless products. PM reported earnings on Thursday before the bell that beat estimates for profit and revenue. Smokeless product revenue increased 34% from a year ago. But the full-year earnings outlook fell short of the analyst estimate. Currency exchange rates are also expected to take an 8% to 9.5% chunk out of earnings.

Analysts were oddly silent on PM’s report. In fact, I couldn’t find a single rating mention or price target adjustment for the $150 billion market-cap company (the last one was nearly a month ago). The current view toward PM is firmly bullish, however, while the average price target is around 15% above Friday’s closing price.

With no help from analysts, we turn to the charts. In the two days after earnings, the stock drifted lower by a little more than 1%. For the past year, the shares have done little, netting a gain of less than 2%. The key to this trade is the 100 level, which put a lid on a six-week rally that covered about 13%. This level marked tops in March and April as well. Before that, it served as support from December through mid-February. Based on this history, we’re going with a call spread with the short strike at the 100 level.

If you agree that PM will continue to struggle with this resistance, consider the following credit spread trade that relies on the stock staying below $100 (blue line) through expiration in 6 weeks:

Buy to Open the PM 1 Sep 103 call (PM230901C103)
Sell to Open the PM 1 Sep 100 call (PM230901C100) for a credit of $0.65 (selling a vertical)

This credit is $0.05 less than the mid-point price of the spread at Friday’s $97.52 close.  Unless PM falls sharply at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $63.70. This trade reduces your buying power by $300, making your net investment $236.30 per spread ($300 – $63.70). If PM closes below $100 on Sep. 1, the options will expire worthless and your return on the spread would be 27% ($63.70/$236.30).  

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