Call Option Volume High on Zynga Prior to Earnings

Zynga (ZNGA) – the creator of Farmville, Citiville, Petville, etc.- will enter earnings-ville for the first time as a publicly traded company after the close this afternoon. Wall Street is expecting a fourth-quarter profit of 3 cents per share from the casual-gaming guru, with revenue seen spiking 54% to $302 million from $195.8 million in the same period last year. With Zynga accounting for roughly 12% of Facebook’s revenue, you can bet that investors and analysts will be paying close attention tonight’s report.

Expectations are mixed ahead of the event. For instance, five of the 10 analysts following Zynga rate the stock a Buy or better, compared to four Holds and just one Sell rating. Meanwhile, the 12-month consensus price target for ZNGA shares rests at $12, a discount of nearly 12% to the stock’s close at $13.42 on Monday. Upgrades or price-target increases could bring additional buyers to the table.

While the brokerage community bulls are dragging their feet on ZNGA, options traders appear to be loading up on bullish bets. On Monday, more than 74,000 calls traded on ZNGA, compared to a modest put volume of 21,700 contracts. The result was an optimistically skewed single-session put/call volume ratio of 0.29. In other words, call volume more than tripled put volume heading into today’s earnings report.

The most popular call yesterday was the March 11 strike, where 15,694 contracts traded on open interest of 16,161 contracts. Following at a close second is the March 13 strike, where 15,830 contracts crossed the tape on open interest of just 3,065 contracts.

Taking a closer look at this activity reveals that one trader might have rolled an existing cal position higher, as 8,600 March 11 calls were sold at the same time 8,600 March 13 calls were bought. With ZNGA trading north of $13, the trader banked a profit of $1.04 per contract, even after buying the March 13 calls. I find this scenario most likely since open interest at the March 11 strike was higher yesterday’s volume, while open interest at the March 13 strike was considerably lower than Monday’s volume. Furthermore, open interest at the March 11 strike fell to 11,268 contracts, while open interest at the March 13 strike rose to 17,878 contracts.

There is also the possibility that the trader was opening an in-the-money bear call spread. In this scenario, the trader sold (to open) the March 11 calls while simultaneously buying the March 13 calls. The end result was a net credit of $1.04 per contract, but the trader will only be able to keep this credit if ZNGA falls 18% to $11 – home to the sold March 11 call.

Technically, ZNGA has been on fire since its initial public offering. The shares are up more than 34% since December, with ZNGA spending the past several sessions consolidating just below $15. Furthermore, this consolidation period has created a bullish technical pattern called a flag.

ZNGA could rally sharply if this flag formation resolves to the upside

Flags are continuation patterns formed when a stock rallies sharply, consolidates for a period, then resumes its uptrend with another sharp move higher. The upper rail of this flag rests in the $14.50-15 area, and a move above this in the wake of tonight’s quarterly report could be the beginning of another upleg for ZNGA.

Go to Forbes for the rest of the story

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