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Morning Update

Yesterday shares of GM led the market down, closing down over 2% and extending the losses it has experienced since reporting earnings on 2/14. Option activity was bullish however, with calls trading nearly twice their average daily volume. Much of the volume was concentrated in the June 35 calls which traded 35,580 contracts, 98% of which were bought. It appears that one trader bought the bulk of these in a single block trade. The trade went down at an average price of $0.,14 with GM at 27.70. This is a bullish trade that will profit if GM rises by 27% over the next 120 days.

Last Thursday GM reported solid fourth quarter earnings. Revenue rose 3% year-over-year to $39.5 billion and earnings per share rose 23%. What has sent the shares down since then was that North American operating margins declined 0.70% year over year to 5.8%. GM’s European division lost $700 million in the fourth quarter and $1.8 billion for the year. The picture is a bit brighter in South America, where GM has a 17% market share and made $100 last quarter versus a $225 million loss in Q4 last year. Going forward the key will be to bring its European division back to profitability, which GM estimates will occur in two years. In the meantime GM also needs to focus on increasing North American margins. Ford has done this and has shown it is possible, which means GM shareholders are likely to continue selling if margins show another decrease next quarter.

This option trade is a shot that GM shares are oversold and will rebound. Fundamentally, the company is relatively cheap considering its forward P/E of 7.6 and that it generated $4.3 billion in free cash flow for the year. Technically speaking, the stock has been trading in an upward sloping channel and is nearing the bottom end of that range. A technical bounce could occur in the 26-26.50 range that would send the stock higher in the near term.

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