Susquehanna Financial Group Derivative Strategist Christopher Jacobson takes a close look at Pandora Media Inc (NYSE:P), contending that the ASCAP/Pandora composer fee trial will see Pandora reverse its recent slump and act as a catalyst for the stock.
In light of our bullish fundamental outlook and our belief that the upcoming ruling in the pending trial vs. ASCAP regarding composer fees could be a catalyst for the stock, particularly in light of its recent decline, we recommend the March 28 weekly expiration 35.5 strike calls in Pandora Media Inc (NYSE:P).
Near-Term Calls in Pandora Ahead of ASCAP Ruling
SFG Internet analyst Brian Nowak and SFG Event Driven/Special Situations analyst Thomas Claps have been closely monitoring the ongoing Pandora Media Inc (NYSE:P) vs. ASCAP trail over composer fees. Nowak covers shares of Pandora with a Positive rating and a $41 price target. In his earnings recap published on February 6, Nowak reiterated his bullish fundamental outlook while noting that “Pandora will likely continue to be volatile in the near-term around headlines (ASCAP trial, content negotiations, etc.).” In a more recent note following Pandora’s February user metrics, Nowak discussed the numbers while adding that “we would be adding to positions on any weakness around near-term listener hour/user concerns.” As for the ASCAP trial, closing arguments took place on February 10. At the time, Claps noted that “Pandora seemed to score more points in closing arguments, and Judge Cote’s questions and body language indicated that she may be leaning in Pandora’s favor.”
During Pandora’s closing argument, after its counsel argued that Pandora Media Inc (NYSE:P) should be classified as radio and therefore pay the 1.7% terrestrial radio rate, Judge Cote stated that she also thought Pandora was radio. This is extremely significant because Pandora’s primary argument is that “Pandora is Radio” and therefore should be paying a 1.7% composer fee rate, the same rate as terrestrial radio stations. While Judge Cote could still rule in ASCAP’s favor and issue a higher rate (ASCAP is seeking a rate of up to 3%), her statement concerning the “Pandora is Radio” issue can be viewed as a significant, positive development for Pandora.
Judge Cote seemed focused on the fact that ClearChannel’s iHeartRadio, a customizable internet radio service that is similar to Pandora Media Inc (NYSE:P), is paying the 1.7% terrestrial radio rate. She stated that it was unfair to ask her to require Pandora to pay more than what ASCAP charges a direct competitor — and that it could also raise competition concerns.”
Pandora’s trial prediction
In light of these takeaways, Claps provided the following trial prediction:
“Based on our observations throughout the trial, we believe that Judge Cote will issue a rate somewhere in the low end of the 1.7% to 2.3% of revenue range. Additionally, after signals from Judge Cote today, the odds of a rate at/below 2% have increased significantly. Finally, we believe that there is a very low probability that the rate is set at the high end of ASCAP’s proposed range (3.0%).”
In terms of recent trading, one of the more interesting trades we’ve seen in Pandora Media Inc (NYSE:P) options took place yesterday when an investor sold 7,500 September 29 puts vs. buying 7,500 September 36/46 call spreads, paying $0.10 for the package. Through the trade, it appears as if the investor is using the call spread to gain upside exposure between $36 and $46 while demonstrating a willingness similar to our own to buy on a dip by selling the 29 put to help finance the trade.
While shares gained nearly 4% yesterday, the stock remains off nearly 10% from its recent highs. For those who believe a positive ASCAP ruling could lead to a near-term pop in the shares, particularly in light of the recent weakness, we recommend taking advantage of low nearterm volatility through a purchase of the March 28 weekly expiration 35.5 calls. We choose the March 28 weekly expiration in an effort to be conservative with regards to timing of a ruling, providing 2+ weeks of exposure, while noting that there is no specific deadline for a ruling.
While Pandora Media Inc (NYSE:P) implied volatility remains high in absolute terms, it is now near the low end of past levels despite the existence of this potential catalyst (30-Day volatility in the 13th percentile).
Specifically, investors could look at the March 28 expiration 35.5 calls. Based on yesterday’s closing stock price of $35.54, the calls could be purchased in the market for $1.59, setting up an expiration breakeven of $37.09, with risk on the downside limited to the premium paid.
Pandora’s trading recap
Takeaways from yesterday include continued upside positioning in gold-related products as well as bearish flow in a handful of U.S. sector products. Beginning with gold, with the spot currency trading up to a 6 mo high of about $1371 overnight, GLD investors were mainly rolling up long calls to higher strike calls in April and May. For instance, an investor sold 6k April 130 (.61d) calls to buy 8k May 137 (.28d) calls. There was also outright March and April 135 call buying. In the GDX (Gold Miners), where call buyers have dominated for the past few months as shares have rallied 30% in 3 months, call buying was muted until the end of day when investors bought 5k Apr11 weekly 27 (.51d) calls. In contrast, trading was bearish yesterday in the XLP (Staples) and even more so in the XLI (Industrial). In the XLI, an investor bought 25k Jun 46/51 put spreads for $1.02, getting short 725k deltas ($40 mln notional). Meanwhile in the XLP, an investor sold 15k March 42 (.26d) puts to buy 10k Apr 43 (.63d) puts, rolling to a deeper delta/higher strike put in April, creating ~240k deltas for sale.
Risks for Pandora
Buying Call: If at expiration the stock finishes below the strike price, the risk to the investor is losing the entire premium paid. The call is profitable if at expiration the stock finishes above the strike price plus the premium paid for the call.
Buying Call Spread: Buying a call spread is buying a call and selling a call with a higher strike that has the same underlying and expiration. If at expiration the stock finishes below the lower strike price, the risk to the investor is losing the entire premium paid for the spread. The call spread is profitable if at expiration the stock finishes above the lower strike price plus the premium paid for the call spread. The call spread’s maximum payout occurs when the stock finishes at the higher struck call at expiration.
Buying Put: If at expiration the stock finishes above the strike price, the risk to the investor is losing the entire premium paid. The put is profitable if at expiration the stock finishes below the strike price minus the premium paid for the put.
Buying Put Spread: Buying a put spread is buying a put and selling a put with a lower strike that has the same underlying and expiration. If at expiration the stock finishes above the higher strike priced put, the risk to the investor is losing the entire premium paid for the spread. The put spread is profitable if at expiration the stock finishes below the higher strike price minus the premium paid for the put spread. The put spread’s maximum payout occurs when the stock finishes at the lower struck put at expiration.
Buying Straddle: Buying a straddle is buying a call and buying a put with the same underlying, strike and expiration. If at expiration the stock finishes at the strike price, the maximum loss occurs of the total premium paid. The straddle is profitable if at expiration the stock finishes above the strike plus the total premium paid or below the strike price minus the total premium paid.
Selling Call: (Naked – no underlying stock position) If at expiration the stock finishes above the strike price, the risk to the investor is unlimited. The short call is profitable if at expiration the stock finishes below the strike price plus the premium collected for the call. (Covered – versus an underlying stock position) If at expiration the stock finishes above the strike price, the risk to the investor is limiting their upside profit on long stock to strike price plus premium collected for the call. If at expiration the stock finishes below the strike price, the investor profits on the premium collected from the call sale which may help enhance stock returns or offset stock loses.
Selling Call Spread: Selling a call spread is selling a call and buying a call with a higher strike that has the same underlying and expiration. If at expiration the stock finishes above the lower strike price, the risk to the investor is losing the entire premium collected for the sale, with a maximum loss of the difference between the strikes minus the premium collected. The call spread is profitable if at expiration the stock finishes below the lower strike price plus the premium collected for the call spread. The call spread sale’s maximum payout occurs when the stock finishes at the lower struck call at expiration.
Selling Put: One risk to selling a put is that if assigned on the short put, investors will be forced to buy shares at the strike price, minus any premium collected for the sale. If at expiration the stock finishes below the strike price, the maximum risk to the investor is the strike price minus the premium collected. The put is profitable if at expiration the stock finishes above the strike price and the investor collects the premium for the put sale.
Selling Put Spread: Selling a put spread is selling a put and buying a put with a lower strike that has the same underlying and expiration. If at expiration the stock finishes below the higher strike priced put, the risk to the investor is losing the entire premium collected for the sale of the spread, with a maximum loss of the difference between the strikes minus the premium collected. The put spread is profitable if at expiration the stock finishes above the higher strike price minus the premium collected for the put spread. The put spread’s maximum payout occurs when the stock finishes at the higher struck put at expiration.
Selling Straddle: Selling a straddle is selling a call and selling a put with the same underlying, strike and expiration. If at expiration the stock finishes above the strike price plus the total premium collected or below the strike price minus the total premium collected, the maximum loss is unlimited. The straddle is most profitable if at expiration the stock finishes at the strike price and the investor collects the premium.
