Where there’s smoke…
06/22/18

Just about two months ago, tobacco giant Philip Morris (PM) suffered its worst-ever one-day drop, a nearly $16 nosedive on April 19 that took the stock, which had already been trending lower, from above $101 to $85.64 after the company released its quarterly numbers.

The report (which beat earnings estimates) revealed weaker-than-expected sales in vaping products—part of the “reduced-risk products” (RRP) market the firm was pushing into as a driver of future revenue in a tobacco world increasingly restrained by regulation and health concerns.1

Philip Morris (PM), 12/29/17 – 6/21/18. Philip Morris (PM) daily price chart. Drop on earnings.

Source: OptionsHouse

After sliding lower over the next month or so, PM shares dropped as low as $76.21 on June 6 before staging a modest bounce the past couple of weeks, as shown in the daily chart (above).

If the April sell-off was enough to prompt certain analysts to call the stock a bargain—Morgan Stanley doubled down by reiterating its “overweight” (strong buy) rating and $123 price target right after the earnings release2—the move to the early June low was likely very conspicuous to long-time Philip Morris watchers in that it took shares to a 4.5-year-old support level that has served as a springboard for bounces or rallies three times since 2014, as shown in the following weekly chart:

Philip Morris (PM), 12/22/08 – 6/21/18. Philip Morris (PM) weekly price chart. Line in the sand

Source: OptionsHouse

While it’s too early to call the current bounce a clear victory for the bulls, some potentially encouraging data from convenience stores recently indicated stable demand and rising sales for vaping-related products, which are potentially high-margin products for PM.3 And lest anyone forget, although PM missed its most recent revenue estimate in April, those revenues were nonetheless $6.9 billion. Tobacco is still big business.

On the other side of the coin, of course, a breakdown below such a notable support level could trigger stop-loss orders and at least a short-term momentum down move.

But for bullish traders viewing the support level as a possible barrier to further selling, PM may offer limited risk relative to its (potential) upside. Even traders who don’t expect a return to the 2017 highs above $120 may view a bounce to the pre-earnings swing low around $95.50 as a reasonable target.

LiveAction scan: Implied volatility increase. 42% IV increase

Source: OptionsHouse

Also, options traders may be able to take advantage of relatively inflated premiums. Yesterday PM showed up on a LiveAction scan of options with the largest increases in 30-day implied volatility (IV) over the past week (above). Because higher IV—which is the market’s estimate of future volatility—can result in higher options prices, bullish traders could alternately choose to sell PM options to take advantage of a potential up move in the stock.
PM July $74 put option. Short put profile

Source: OptionsHouse

As an example, the chart above shows the reward-risk profile for selling 10 July $74 PM put options (note the strike price is a little below the long-term support level) expiring on July 20. Although the position has theoretically unlimited risk (since a price drop below the strike price could result in long PM stock position at that price), in practice traders can cover their positions any time they want prior to expiration, and short options positions benefit from time decay—the natural tendency of options to lose value over time, and lose more of it the closer they get to expiration.

In trading, there's often more than one road that can take you to your ultimate destination.

 

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1 Zack’s.com. Can RRPS, Pricing Aid Revival at Philip Morris (PM) Stock? 6/19/18.

2 StreetInsider. Morgan Stanley Remains Bullish on Philip Morris (PM). 4/20/18.

3 Morningstar. Top 10 Holdings of Our Ultimate Stock-Pickers Index. 6/19/18.