by riskreversal February 4, 2011 9:24 am • Commentary

AKAM reports q4 earnings Feb 9th after the close.

Price Action/Options Market Forecast/Vol Commentary:
Options Market pricing ~9% move post earnings vs its 8qtr avg move of ~12% ( 5 moves of 13% or greater, 3 of which were at least 18% moves)
–ATM implied vol in feb trading at almost 20 point premium to the 60 day realized and almost 10 point premium to march which does not capture earnings.
–with generally flat skew option trader generally undecided or less worried about one direction or the other……

-while the company appears to be poised for healthy sales and earnings growth in 2011 estimated at ~17%, they face increasing competition on pricing for their core content delivery offerings which could hamper margins…..if the company offers guidance next week that shows some cracks in their guidance stock could be vulnerable near term given its very high valuation, company trades at almost 9x sales which makes it a very difficult target for any potential acquirer given the premium that would need to be paid for the company.
–Since VZ‘s recent takeover offer for Terremark there has been much speculation that a large Telco or an even larger cash rich Tech company such as AAPL, GOOG, or CSCO could be interested in AKAM, EQIX or FFIV.
-While the asset may be complimentary the valuation makes it nearly impossible to make it work…
-As recently as DEC at AKAM’s annual analyst day, the company laid out their 10 yr goal to grown sales 5 fold, which doesn’t really help the case for accretion to a buyer given the amount of R&D it would take to get to that number and the damage it would do to margins….
–that said at some point some of these large tech companies are going to need to put that cash to work and if all the smaller players get gobbled up they will move upstream

-Since making a low about a year ago the stock is up almost 100% after making a series of higher highs and higher lows.
-since stock made a new multi year high in early Dec the stock has essentially been going sideways forming an interesting flag pattern or a wedge. Near term events should resolve this soon…..



If you are long and worry about the potential for an outside move lower, or even one inline with the implied move of ~9% look to collars to offer some additional near term upside but given you protection at some point.

TRADE: AGAINST A LONG BUY the Feb 52.50/ 45 collar for .18
-SELL as if 1 up to stock 1 Feb 52.50 call and use the proceeds to
-BUY 1 Feb 45 Put for .92

Break-Evens on Feb Exp;
Neutral: stock between 45 and 52.5 you essentially make or lose based on stock price, but lose the .18 premium you paid for the protection
Upside: stock 52.50 or higher your stock is called away, but you made 4.40 or ~9%
Downside: stock 45 or lower you have protection but lost 3.10 or ~6.5%

if you think the stock will not make an outside move on earnings use the heightened volatility levels to add yeild to a long…..
TRADE: AGAINST A LONG SELL the FEB 52.5/44 Strangle for 1.37 or ~3% of the underlying…
-SELL 1,Feb 52.5 call for .73 and
-SELL 1 Feb 44 Put for .64

Break-Evens on Feb Exp;
Neutral: stock between 44 and 52.5 and both options expire worthless and you take in the premium, but make or lose with the stocks movement.
Upside: stock btw 48.10 and 52.5 and u make money on your long stock and you take in the premium.
Downside: the 1.37 in premium that you receive for selling the strangle acts as a cushion the downside, but btw 46.73 (current price of 48.10 less the 1.37 in premium) and 44 (the put strike you are short) you have no protection and you lose below there….
WORST CASE: stock below 44 and you are put the stock, so you effectively have added risk and doubled up on your long down 8.5%….
** in the collar i suggested doing it 1 up to the stock position that you own, from a risk management standpoint long holders who want to sell strangles have to be very comfortable of buying the stock at the put strike they sold, so you don’t have to sell as if 1 up, u could gage to how much stock you would actually considering buying to add to your position if the stock were to go lower.

3. STOCK REPLACEMENT SELL YOUR LONG and replace with a Call Spread Risk Reversal in Jan12
TRADE: BUY the JAN12 50/57.50 Call Spread for ~2.80 and Sell the Jan12 35 Put for 2.30
-BUY 1 Jan12 50 Call for 6.90 and
-SELL 1 Jan12 57.5 Call for 4.10 and Finance by
-SELLING 1 Jan 12 35 Put for 2.30
STRUCTURE COSTS ~.50 or 1% of the Underlying

Break-Evens on Jan12 Expiration:
-Neutral btw 50 and 35 (down 27%) you lose the .50 premium you paid.
-Upside: btw 50 and 57.50 you can make up 7.00 (diff btw strikes less the premium), if stock 57.50 on Jan12 exp you make 7.00 or 14.5%…
-WORST CASE stck 35 or lower you are put the stock and you start you lose money.
**if stock has sudden move lower you will have mark to market loses between now and Jan12 exp
** rationale for this trade structure is that you get near the money participation of being long with out the risk of continuing to own the stock up 100% in a year.

4. BUY THE MOVE–Technicals look like this thing is ready to go one way or the other…..stock chart like a coiled spring.
TRADE: Buy the Feb 46/50 Strangle for ~2.65 or ~5.5% of the underlying….
-Buy 1 Feb 46 Put for 1.25 and
-Buy 1 Feb 50 Call for 1.40

Break-evens on Feb Exp:
Worst case; stock btw 50 and 46 and u lose the 2.65 in premium you paid…..
-Upside: stock 52.65 (up 9.5%) or higher you make money on expiration
-Downside: stock 43.35 (down 9.5%) or lower you make money.
**likelihood of losing all of your premium is not great as both options will have value immediately after earnings even if even if the stock does nothing…..  for instance if the stock were at 50 up 1.90 after earnings, the Feb 50 call would likely be worth $1.

UPDATED 2/10/11 at 10.30am: A lot of these tech high-fliers are priced to perfection and you would have to be crazy to short them outright, but my sense (hope) is some of them are about to come down to earth in the next couple months and make them invest-able equities again.  AKAM is down 16% as of 11am this morning after posting inline earnings and guidance but offering weaker than expected guidance for Q1.  In my opinion this price action is rational because stocks that are priced for perfection need to continue to put up impressive results and guidance to keep the train moving in the right direction (see AAPL)…as for the trade structures suggested above, depending upon your disposition, 3 of the 4 would have served you, while the only one that would have hurt you would have been the strangle sale against a long.  what is interesting to note is that selling strangles was the only structure that would have layered on additional risk in a meaningful way in the near term…if the stock were to stay here between now and Feb Exp (next fri) you would be put the stock at 44 or almost $4 higher….so not only did you lose almost $8 on the stock that you owned into earnings, but you will lose an additional $4 for the chance that the move was smaller than what the options market was predicting, not a great risk reward.  that is why i focused most of my energy when looking at the name to focus on defensive structures, collars, stock replacement and buying strangles (not defensive but a play on large move).


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