Why Transocean Stock Could Pop After Earnings

Offshore drilling contractor Transocean Ltd. (NYSE:RIG) is slated to report fourth-quarter earnings after the market closes next Tuesday, Feb. 20, with consensus estimates calling for a loss of 27 cents per share. RIG has managed to trade higher the day after earnings following six of its last eight quarterly reports -- but ahead of next week's reports, traders on Wall Street appear to be bracing for a big disappointment.

For starters, short interest on RIG rose by 6.5% in the latest reporting period to total 87.2 million shares -- just a stone's throw from an annual high. Short interest now accounts for a hefty 22.3% of the equity's float, or 6.6 times Transocean's average daily trading volume. That's a pretty formidable supply of bearish bets.

Likewise, speculative players have shown a stronger-than-usual interest in put options on RIG ahead of earnings. During the past 10 sessions, traders on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) bought to open 12,715 puts on RIG, compared to 12,686 calls. The resulting 10-day put/call volume ratio of 1.00 registers in the 99th percentile of its annual range, which means options buyers have rarely shown a more pronounced preference for bearish bets over bullish.

Analysts are also crowded into the bearish camp. Among the 19 brokerage firms tracking Transocean shares, 13 call the stock a "hold" or "strong sell." And earlier this week, Evercore ISI -- one of the few firms with an upbeat "outperform" rating on the equity -- cut its price target to $20 from $21.

In light of RIG's long-term underperformance on the charts, this widespread negativity isn't exactly shocking. At its current perch of $9.17, RIG is down nearly 38% from its year-end 2016 levels, and the shares recently tumbled through tentative support at their 40-day, 80-day, and 160-day moving averages.

That said, the oil-and-gas issue appears to be testing a possible floor around the $9 level, which previously acted as resistance during the second half of 2017. And the stock's 14-day Relative Strength Index (RSI) has been hovering in the low 30s for well over a week now.

With plenty of pessimism priced into RIG from all corners, and the recently oversold stock testing support on the charts, the stage would appear to be set for a post-earnings bounce (though most likely of the "dead cat" variety) in the event of some stronger-than-expected numbers next Tuesday evening.

However, prospective short-term premium buyers should proceed with caution. Currently, the options market is pricing in a post-event price swing of 5.1% for RIG, compared to its average daily post-earnings move of 3.9% over the past eight quarters, according to Trade-Alert. In fact, 30-day at-the-money implied volatility on RIG options currently stand at 50.7%, in the 87th annual percentile -- suggesting short-term contracts have priced in higher volatility expectations only 13% of the time, and effectively raising the risk of a post-event volatility crush.