Do you buy UPS ahead of earnings?

United Parcel Service, Inc. (NYSE: UPS) has very close ties to the economic health of the U.S.  Aside from the shipping giant’s earnings, which are due tomorrow before market open, there is a slew of big economic data out this week, including pending home sales, ISM Non-Manufacturing Data, weekly unemployment claims, and Friday’s ever-important non-farm employment numbers.

Jobs, or the lack thereof, have become the President’s priority (we hope so) but more importantly, for your money, the employment picture has become more of a market focus as well.  Now that we have realized an exponential price gain in the S&P over the past nine months and returned to a more “growth oriented” profit picture, the market realizes that in order for continued growth, American citizens need to be able to spend.

The jobs picture will have to improve if the U.S. equity markets are to continue to grow. With that, UPS (who ships a large amount of the goods our companies produce and consumers buy) will be extra-sensitive to these numbers.  This is especially true in the next year, as traders will be looking for not only a reduction in the nation’s unemployment, but real top-line growth within companies that hire our neighbors and enable us to consume their goods and use their services.  If companies are cutting costs by slashing their workforce, that most likely will NOT translate into strength for the consumer and certainly not in wages earned or spending activity.

As for UPS, I believe they have a challenge ahead of them. UPS has MISSED estimates the last four quarters and with 15 analysts covering UPS, the consensus earnings per share estimate is $0.73, and the high and low estimates are $0.75 and $0.63, respectively. UPS is currently trading at roughly 24x trailing earnings. What is even more interesting about UPS and the market’s reaction to its shortfalls is that it actually has more of a history of rallying slightly on the release as opposed to the expected selloff. UPS is not a big mover in either direction over earnings, with an average move of less than 3.5%.

Taking a look at the volatility picture, UPS has seen both its 30-day observed volatility and its implied volatility on the rise.  As of Friday, 30-day observed volatility was roughly 24.75%, with implied volatility on the front-month options coming in slightly higher at about 27%.

Given the data that is on tap for the week, I would be careful not to take on a uni-directional trade, because the near future is just so unclear. Not to mention, the new market mantra (at least for the next couple of weeks) is to “sell the rallies,” as the market has been unable to hold its bids.

Technically speaking, UPS has had a wild ride along with the rest of the marketplace the past couple weeks.  We saw a rally in UPS shares to $63.38 and then a subsequent selloff to its current level of $57.59.  There seems to be some stickiness around the $57-$58 area and the next stop for support comes at about $53.00. Volatility has swelled quite a bit, indicated by the gap in the stock’s Bollinger bands.  Currently, momentum seems to be to the downside.

UPS is also below its 20- and 50-day moving averages, which takes a bit of credence away from the support immediately below it. The 200-day moving average comes at about $55.00.

The trade of choice, I believe at this point will be a moderately short volatility trade with some flexibility in movement. I have been on a ratio spread kick and I think the March 57.50/55 put 1-by-2 put spread seems to fit my thesis.  It’s a moderately bearish trade that would be the most profitable if UPS expires at 55 by expiration.

But if UPS decides to stay put and rally, we get to keep the 34-cent credit that we collect at the onset. Breakeven for this trade is at $52.16, all the way down below the 200-day simple moving average, which gives me some comfort. That’s not to say that a sharp selloff is not possible. If UPS drops on earnings and I can sell this spread back to the market for even or better and the market begins to look nasty, I would probably exit. But this trade does offer us a nice range on a stock that will most likely mimic the already skittish nature of the broad market.

By opening a free virtual trading account with OptionsHouse, you can build a profit/loss diagram (such as the one below) to help visualize this trade.