CSCO Catch Up Play: Potentially Add 6.5% Yield By June Expiration For Next To Nothing

by Dan April 29, 2011 6:53 am • Commentary

Bull markets, like the one we are obviously in right now, can be cruel even to stocks once synonymous with the term “bull market”.  Take CSCO for example. The once great Tech titan is down almost 15% year to date, massively under-performing the Nasdaq which is up ~7% and peers like JNPR, up 5%.

There are three very good reasons why the stock is down almost 37% from the highs made last year. Those reasons are three consecutive earnings and guidance disappointments.

But even in the face of disappointing stock performance the options market can offer unique ways to protect gains, add leverage, or in this instance add yield to your equity position without adding any additional risk.

If you own the stock, and are frustrated with its under-performance but are not inclined to sell here and you think there is a chance that a lot of bad news is already in the stock, you could consider ways to leverage that long position into the earnings on May 11.

One way is by adding a 1×2 call spread to your long stock.


-Long CSCO at ~17.30

-Buy 1 June 19 call for .22 and

-Sell 2 of the June 20 calls for a total of .20 (.10 each)

(In this example the CSCO JUN 1×2 Call Spread costs you .02)

Break-Evens on June Expiration:

Downside: If the stock is below 17.30 you suffer loses as you would if you were just long the stock, plus the loss of the .02 in premium that you paid for the call spread.


-Between 17.32 and 20 you make the gains of your long stock.

-Between 19 and 20 you can make up to .98 plus the gains in your stock.

-Best case scenario the stock closes at 20 (up ~15% ) and you would make 2.68 in your stock and .98 in the call spread (or nearly an extra 6.5% yield from the options overlay).

-Stock above 20 on June expiration your long stock is called away up 15% and your call spread expires worth .98, so you have effectively made ~22%.

TRADE RATIONALE: If you are long and not going to sell, but think the stock could have a relief rally if the company was able to beat earnings estimates and maintain or even raise next quarter guidance, it may make sense to consider a strategy like this to help add some yield to your long, with only adding a small premium outlay, which happens to be the only added risk.

There is always the risk that the stock rips and you have essentially given it away at 20. But you would be selling your long at 20.98 (up ~21%) on June expiration (consider that you are long at 17.32 and you wrote one June 20 call against your long position and then you own a June 19/20 call spread that you can make maximum of .98. So effectively you have made 2.68 on your overwrite that is called away and then .98 on your call spread.)

In my opinion, the likelihood of a rally much above 20.98 by June expiration is not great.

-I suggest this for individuals who are already long, as CSCO is a very widely held stock, but for those who arrive at the conclusion that this may be a good entry point, this sort of strategy may make sense as you will be not spending a lot to do it and you have event to help catalyze a potential move.