Apple Inc. (Nasdaq: AAPL) recently announced at its latest developers’ conference that it will be launching Apple Music, a brand new streaming service, and will also let subscribers come in for free for a limited time.
It has them scrambling as the titan just entered their arena. And made Pandora’s odds at success all the longer. Here’s what we’re going to do about it to profit.
A Closer Look at How This Will Set Up Our Profits
Pandora, the streaming music pioneer, was struggling prior to its latest round of bad news. Competition in the online music industry was already fierce, before Apple’s entry.
Subscribing to a paid music service is something that mainstream America is still acclimating to, not unlike the initial hurdle cable television had to clear in its infancy.
Pandora has free music channels, but with Apple entering the market, I am expecting an additional 25% drop in its paid subscriber base.
Its slumping stock price only underscores my pessimism. As we see in the above graph, it’s off more than 50% from its 2013 height.
So where is Pandora going? The path of least resistance is down, but what’s the probability that it will continue to go down, how far, and where’s the opportunity in a $16 stock moving lower? Let’s answer those questions and make our move.
The Next Step Is Easy to Predict and Sets Up Our Gain
What is the probability that Pandora stock will continue to trend lower, and how far?
The week following earnings for Pandora stock for the last eight earnings reports has been poor, almost without exception. Yet, when I researched it, I found that Pandora met or exceeded earning expectations for the past eight quarters.
So it wasn’t the reports that drove down the stock. What, then, was it? Let’s take a look at this table.
I refer to it as “Earnings Effects.” It looks at what happened to the stock the following dayafter the earnings report was announced. Notice that in seven of the last eight quarters (highlighted in yellow), Pandora stock was trading lower, with a 13.68% downturn as the average.
So this tells me it’s not the actual number. It’s market expectations of a better-than-reported number. Remarkably, even good news for Pandora has proven bad for its stock!
Based on my research, the chances are good that the trend will continue.
How can someone profit from shorting such a cheap stock? By buying puts, that’s how! A put option grants the buyer the right to sell a stock at a set price for a set amount of time.
Let’s put this in perspective with Pandora.
The graph above shows the P September 2015 $16 puts (P150918P00016000) trading around $120 a contract.
That means we have the right to sell Pandora at $16 between now and September 18 and for this it takes $120 per contract.
The worst-case scenario is that Pandora goes nowhere, or up, and the most we lose is $120 per contract plus commissions.
What we are looking for is another Money Calendar indication that Pandora will move lower. If we get that average 13.5% move, we should expect the options to be a worth a minimum value of 2 points, or a 75% increase in value on the options.
As Pandora reels, don’t fret. Using my method, it’s easier (and more fun) to profit!
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