Bloomberg News

CVS Calls Pay 82% as Profit Spurs Best Rally Since 2010: Options

November 07, 2011

Nov. 4 (Bloomberg) -- CVS Caremark Corp. options traders who boosted bullish bets at the fastest rate since January reaped gains of 82 percent and more after the company exceeded analysts’ profit forecasts.

Calls that pay should the stock rise above $38 in the next two weeks climbed to 47 cents from 27 cents after earnings at the biggest U.S. provider of prescription drugs climbed 8.3 percent from a year ago. That was the most actively traded CVS contract since Oct. 20, data compiled by Bloomberg and Trade Alert LLC show.

Options traders snapped up bullish contracts before CVS’s earnings announcement, pushing the number of calls to 1.32 times puts to sell on Oct. 31, the highest level since May. The stock rallied 4.3 percent to $37.31 yesterday, the most since February 2010, after the company raised the lower end of its 2011 profit forecast and said it can “return significant value to our shareholders,” according to a statement.

“They’ve done a lot to right the ship,” Jeff Bagley, who helps oversee $6.5 billion at Haverford Financial in Radnor, Pennsylvania, and is adding to CVS holdings, said in a Nov. 2 phone interview. “You have an extremely cheap valuation, a turnaround story with the pharmacy benefits manager and new management with a stated goal of returning a tremendous amount of cash.”

Carolyn Castel, a spokeswoman for Woonsocket, Rhode Island- based CVS, declined to comment on the options.

Open Interest

January $40 calls had the largest open interest among all contracts before today. December $39 calls, which give the right to buy the stock at a level it has traded below for three years, rose 157 percent to 54 cents for yesterday’s largest gain.

The ratio of outstanding calls to puts jumped 23 percent from Oct. 20 through the end of the month, the fastest for a comparable period since January, Bloomberg data show.

Implied volatility, the key gauge of options prices, for CVS contracts expiring in 30 days fell to 24.85 yesterday, down from this year’s peak of 39.19 in August. The VIX, as the Chicago Board Options Exchange Volatility Index is known, fell 1.1 percent to 30.16 today, slumping a third straight day. In Europe, the VStoxx Index added 3.6 percent to 41.49.

Traders “were pretty good on their estimation of what was likely to happen after earnings,” Caitlin Duffy, an options analyst at Greenwich, Connecticut-based Interactive Brokers Group Inc., said in a phone interview yesterday. “For someone who’s savvy and knows what they’re doing, then using the leverage might make more sense.”

Topping Estimates

CVS third-quarter adjusted per-share earnings of 70 cents beat the 68-cent average of 20 analyst estimates in a Bloomberg survey. The company raised its full-year adjusted earnings forecast to at least $2.77, up from $2.75. It has a “buy” rating from 20 analysts and a “hold” from five, with no “sells,” according to Bloomberg data.

The benefit-management division had revenue of $14.59 billion in the quarter ended June 30, a 23 percent increase from the prior year. In August, CVS said the PBM segment would have “dramatic” improvement in the fourth quarter over the prior three months.

CVS’s PBM business has benefited from new contracts this year. Customers such as the California Public Employees’ Retirement System and the state of Hawaii may help boost 2012 sales by $4.8 billion, Bloomberg Industries data show.

Benefit managers may be hurt as the unemployment rate remains at 9.1 percent, keeping people off employer health- insurance rolls and making some customers more cautious about spending money to fill prescription, according to Bloomberg Industries. The industry also faces scrutiny from Congress about competitiveness.

One-Day Wonder

Rallies in stocks where a majority of analysts recommend buying it may be temporary, said Michael Khouw, director of U.S. equity derivatives trading at Cantor Fitzgerald LP in New York.

“When a stock is so liked, if anything happens you could see very swift pullbacks,” Khouw said in a phone interview yesterday. “The money may start to race for the exits so you get into these traps and there’s nowhere for sentiment to go but down at that point. Even if you’re bullish about a company’s prospects when everyone else is looking up, look down.”

CVS has surpassed estimates for quarterly earnings throughout 2011. Profits in the three months ended June 30 rose 8.3 percent to 70 cents a share, exceeding the average analyst projection by 3.7 percent. The company had the highest level of free cash flow since at least 2002 in the first quarter of this year. The April-to-June period was the second-highest, data compiled by Bloomberg show.

Annual Gain

CVS has climbed 7.3 percent this year, compared with a 16 percent drop for rival Walgreen Co. and a 19 percent decline for drug-benefits manager Express Scripts Inc., which is seeking to buy rival Medco Health Solutions Inc. CVS is valued at 14.5 times earnings for the previous year, versus 12.3 for Walgreen and 17 for Express Scripts, Bloomberg data show.

The November $38 calls had the highest volume among all CVS options in the two weeks before the earnings report, and 56 percent of those contracts traded on the ask price, indicating that buyers initiated most of the trades, according to Trade Alert data. Those contracts accounted for 9.3 percent of volume during that period, and their open interest more than doubled to 15,219 contracts, according to Bloomberg data.

“Options are one of the best way to play an earnings event because you can make such a specific bet in terms of direction, magnitude and timing,” Henry Schwartz, president of Trade Alert, a New York-based provider of options-market data and analytics, said in a phone interview yesterday. “There’s often a predominant directional bias to flow heading into earnings and in this case it was right.”

--With assistance from Kaitlyn Kiernan in New York and Chris Burritt in Greensboro. Editors: Joanna Ossinger, Chris Nagi

To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net; Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net


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