Game Not Over on Zynga?

12/14/2012 8:00 am EST


With its dismal post-IPO performance and announcement of a pending “divorce” from Facebook, many have been speculating whether it’s game over for Zynga. Not so fast, writes Teri Stridsberg of Schaeffer’s Investment Research.

Zynga Inc. (ZNGA) rallied more than 7% on Wednesday, amid reports the company plans to launch its latest casino game offering, Elite Slots, on Facebook Inc. (FB). As such, approximately 45,000 calls had changed hands by the time the closing bell rang, which was more than double the equity's average daily call volume, and 13 times the number of puts traded.

The clear front-runner was the December 2.50 call, where nearly 10,900 contracts crossed the tape—the majority of them at the ask price, pointing to buyer-driven activity. These calls were exchanged at a volume-weighted average price (VWAP) of $0.15. Open interest at this strike rose by almost 3,400 contracts overnight, indicating that some of the volume consisted of new positions. This option now holds peak call open interest of 32,689 contracts. In order for traders to realize a profit on these bought-to-open calls, the stock must rise above $2.65 by front-month expiration.

This preference for calls over puts is nothing new for ZNGA. The equity's 10-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) call/put volume ratio sits at 7.46, confirming calls bought to open have outnumbered puts by a margin of more than seven to one during the past two weeks. This ratio ranks higher than 86% of other such readings collected within the past year, meaning speculators have been picking up calls over puts at a faster-than-usual pace. In a similar vein, the stock's Schaeffer's put/call open interest ratio (SOIR) checks in at 0.52, with calls nearly doubling puts among the front three-months' series of options.

It's worth noting that short interest on the Internet game provider spiked by more than 21% during the most recent reporting period, raising the possibility that some of the recent call-buying activity could be the result of hedging activity by short sellers. However, there is still plenty of room aboard ZNGA's bearish ship, as these shorted shares make up less than 3% of the equity's available float. Of course, with ZNGA priced at $2.63, there is limited downside potential for short sellers to target.

Meanwhile, most of the brokerage firms covering the security maintain a wary attitude toward ZNGA. Only three analysts have handed out "buy" or better recommendations, compared to 13 "holds," and two "sell" or worse suggestions. This caution is not surprising, as the shares have surrendered about 72% year-to-date.

However, things have been looking up for ZNGA in recent weeks. The equity has surged around 25% over the past month, while also outperforming the broader S&P 500 Index (SPX) by more than 16 percentage points during the last 20 sessions. Also, the stock is poised to finish a third consecutive week above its 10-week moving average, which has served as stubborn resistance since early April. Should the stock edge higher over the next several days, Wednesday's traders could end up collecting a profit on their bullish front-month bets.

By Terri Stridsberg of Schaeffer’s Investment Research

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