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Caesars Entertainment (CZR) stock rose today, with unusually high call options volume activity. This was on weak legal news (casinos can use AI to set room rates, with a class action suit dismissed). As a result, call options buyers believe CZR stock will increase over the next two days.
CZR is at $43.38, up over 6.25% today, and has risen over $10 or +30% in the last month from its recent $33.20 low on Aug. 5.
So far this year revenue and earnings have not not been impressive. On July 30, Caesars Entertainment reported slightly lower YoY revenue and flat EBITDA (earnings before interest, taxes, depreciation, and amortization) growth for its quarter ending June 30.
So, it's not clear why there has been a huge jump in CZR call options today. For example, the Barchart Unusual Stock Options Activity Report shows that over 11,000 call options have traded at the $45.00 strike price for expiration on Oct. 4.
These call options are $1.44 over today's spot price, making them out of the money. Since the midprice premium is 20 cents, call option buyers hope to see CSR stock rise to over $45.20 by the close on Friday, Oct. 4.
That means the breakeven price is $1.64 over today's price or 3.76% higher. Moreover, the volume of call options contracts is over 60x the prior number of outstanding call options at this strike price.
As a result, traders in these call options believe that CSR stock will spike in the next few days. That is a highly speculative play. On the other hand, some traders may be shorting these out-of-the-money (OTM) calls.
Short Call Strategy
For example, existing shareholders in CZR stock could be selling covered calls to hedge their bets. They receive 20 cents for every contract shorted this way. That works out to a 0.50% yield over the next two days (i.e., $0.20/$43.56).
Moreover, if CZR rises to $45.00 by Friday's close, the covered call investors will make a total return of 3.76% (i.e., $45.20/$43.56). That could be one way for existing investors to hedge their bets. They get to keep the income no matter what and even if the stock rises they make a good return.
For example, any investor who can make 0.50% every week doing these covered calls has an expected return (ER) of 6.0% (i.e., 0.50% x 12). Annualized that works out to an ER of 24%. That is a very good potential return for many investors.
This could be one reason why so many call options have traded here. Institutional traders and investors are attracted to these kinds of expected returns, especially if done on margin.
CZR Stock's Value and Price Targets
Analysts have slightly higher price targets for CZR stock over the next 12 months. For example, Yahoo! Finance reports that the average of 16 analysts is $52.44. Similarly, Barchart's survey shows a mean price target of $51.69 per share.
These targets are 20% and 18.4% higher than today's price. Moreover, AnaChart, a new sell-side analyst tracking site, reports that 13 analysts who've written recently on CZR stock have an average price target of $54.94. That is over 26% higher than today.
The problem with its valuation is analysts are projecting negative earnings this year. Moreover, from an EV/EBITDA standpoint, it may not be cheap. For example, last quarter it made $1 billion in EBITDA. That puts it on a run-rate of $4 billion in EBITDA this year.
Since Caesars' market cap is $9.4 billion and the company has $11.6 billion in net debt (after cash), its enterprise value (EV) is $21.0 billion. That means its EV/EBITDA ratio is 5.25x on a projected run-rate basis. That is not cheap, but not especially expensive.
The point is that it's hard to see why the stock has spiked today. It's certainly up from lows, but its valuation is not a deep bargain. The news out today also does not affect its valuation.
The bottom line is that astute investors will probably take advantage of this spike. They can sell covered calls with a good expected return, rather than speculating on a rise in the price by Friday's close.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
