IBM reports Q2 guidance after the close tonight and the options market is implying a bit less than 3.5% vs the 4.4% average over the last 4 qtrs.
Since making new all time highs in early April, we have had 2 successful bearish options trades (below), one in May, the June 200/185 Put Spread, and one in June the July 290/180 Put Spread, both we closed for more than 2x what we paid. The premise was simple, U.S. multi-nationals that have benefited from the global growth reflation trade (specifically exposed to emerging markets and Western Europe) coupled with the weak dollar, would now see the former tailwinds serve as headwinds as storm clouds appeared to be gathering as a result of slowing growth in Asia, weakening economic data in the U.S. and an ever increasing recessionary environment in Europe.
With IBM now down about 10.5% from the all time highs, and massively under-performing (up 2.25%ytd) the SPX and the Nasdaq, the trade to press the short doesn’t seem as easy as it did at above $200 or even $195 for that matter.
At this point, in this market that we are in this week, where it appears that bad news is actually good news, shorting anything appears a bit dangerous. Bulls will point to the fact that the company has a lot of levers to pull when it comes to it hitting its earnings guidance (which in fact they have not missed since Q1 2005), the company has a massive buyback, tons of potential cost cutting opportunities and more than 50% of their revenues are recurring. SO with the stock trading at a market multiple, equal to its expected earnings growth rate for 2012, a dividend yield above the 10 year treasury, and the above mentioned under-performance, the stock screens as cheap for many investors and the near term bad news could be in the stock at about $188.
To short the stock at current levels you have to have conviction that the company will miss earnings for the first time in 7 years and that they will issue downside guidance much worse than the street expects. The company doesn’t give revenue guidance quarterly, so this could be a bit of a guessing game, but at this point I think a low single digit revenue miss is possibly in the stock.
My view hasn’t changed much on the name, but at this point it is more of a market call. I think the most prudent thing to do would be to wait until after the print. I think it is a market call at this point, I have little conviction to press the short, so I am going to avoid the trade.
Here is a quick preview of what to expect from IBM from Bloomberg:
● 2Q adj. EPS $3.43, range $3.34-$3.51
● 2Q rev. $26.29b, range $25.86b-$26.7b
● Yr adj. EPS $15.06, range $14.96-$15.25, saw at least $15.00 on Apr. 17, up from at least $14.85
● Yr rev. $107.51b, range $105.88b-$108.77b
WHAT TO WATCH:
● Though potentially volatile, service bookings will be in focus:
**NOTE: 1Q services signings rose 12% to $11.8b
● Results from ACN, SAP, ORCL give “optimism” in services:
● Impact from FX on bottom/top line: Barclays
● Color on relative condition of IT spending market
● IBM reports post-mkt (last 3 4:08pm, 4:03pm, 4:12pm)
● Call at 4:30pm
3rd Trade Update July 10th, 2012 at 11:29am: Closed the balance of this position for more than a double at 3.50 (stock ref $187.80), my average was 1.50. I want to take off some winners that I have sat with, and take some losses on some positions that aren’t working and focus my attention on etfs as we head into earnings and single stock volatility may be hard to predict.
Action: Sold Second 1/2 July 190/180 Put Spread at 3.50 (stock ref 187.80).
2nd Trade Update June 21st, 2012 at 2:59pm: Got a great question from a reader about this IBM put spread and I detailed my thought process in “Quick Hits” soon after (see transcript below). There are many things that we enjoy about our involvement with RiskReversal.com, but none more than seeing our readers take a page from our “trading book” and applying it on their own to their own invest trading process. Thanks G.M. for the heads up.
So back to IBM, I turned a loser into a winner yesterday by getting slightly aggressive and doubling up on my position when the spread had lost more than half of it’s value since initiating last week. I was early, and I often am, but I had conviction. SO to recap on June 11th I bought the July 190/180 ps for 2.05 when the stock was 194.50, yesterday when the stock was 199.50 I doubled up for .97, lowering my average to about 1.50. Now I am going to sell the half that I added yesterday at 1.90. Now I have lowered my cost basis and the stock right back to where I started.
Action: Sold 1/2 July 190/180 Put Spread at 1.90 (stock ref 194.45).
Trade Update 6/20/12 at 1:19pm: With IBM up about 2.5% since initiating this bearish strucuture earlier in the month, I am now going to double up on the position by buying the July 190/180 Put Spread for .97 (stock ref 199.55). My new average is about 1.50.
Action: Bought more July 190/180 Put Spread for .97 (stock ref 199.55). New average is about 1.50.
New Trade: 6/11/2012 at 10.46am: In early May when IBM was trading at $205, I detailed a trade on Options Action (below) that would benefit from the realization by investors that U.S. multinationals with large revenue exposure overseas, could be vulnerable to a Q2 slowdown as a result of the rehash of the debt crisis in Europe.
In a little less than a month I more than doubled my money on that trade as the stock sold off about 7.5% since putting the trade on. I took my money and ran, with an eye towards re-initiating this trade on a bounce.
With an eye towards a weak Q2 earnings report (expected to fall in July expiration), I want to buy another Put Spread in July.
TRADE: IBM ($194.50) Bought the July 190/180 Put Spread for 2.05
- Bought 1 July 190 Put for 3.45
- Sold 1 July 180 Put at 1.40
Break-Even on July Expiration:
- Profits btwn 187.95 and 180, make up to 7.95, mae gain 180 or lower of 7.95 or about 4x your money.
- Losses of up to 2.05 btwn 187.95 and 190 and max loss of 2.05 above 190
Trade Update: 6/1/2012 2:30pm:
With IBM trading at $189, we’re going to take this spread off for 8.00 dollars. Paid 3.40. This isn’t a call on a market bottom as much as a new risk reward view in the price of the spread. We are still of the belief that multi-nationals will have challenged Q2 results and murky guidance for the second half, we will look for a better entry point to re-short.
Original Trade Post May 4th 2012:
Here is a preview of what I will be discussing on Options Action tonight on CNBC at 5pm:
A few weeks back, IBM reported Q1 earnings that was a bit of a mixed bag and resulted in a 3.5% sell off in the shares the next day. The company registered a solid beat on the earnings front, and even raised their full yr eps guidance by about 1%, but missed consensus revenue estimates which is somewhat surprising when some analysts speculated the qtr benefited by almost $300 million from currency benefits and completed acquisitions in the qtr. There were a few warning signs in the results as some analysts highlighted Services revenues that were light, Services signings light and Backlog growth that was flat year or year.
IBM trades at a slight premium to its eps growth rate, which is basically inconsequential to most investors, but in-light of the recent tepid results, and the fact that revenues are only expected to grow 1% this year and 3% next, investors could hit the pause button as we get deeper in what appears to be an increasingly murky economic environment in Q2.
Q1 is history, and prior to today, the stock has basically recaptured all of the loses post earnings and now sits about 2.8% away from the all time highs made early last month. Obviously I want to take another crack on the short side in this name, and the post yesterday from Bespoke Investment Group about multi-nationals with international exposure only reinforced my bearish view.
It was well documented that the stocks with heavy international exposure outperformed by quite a wide margin in the first quarter of this year. April was a different story, however. With Europe running into serious trouble early in the month, US companies that generate a large portion of their revenues outside of the country took a hit.
To highlight the underperformance, we broke the S&P 500 into deciles (10 groups of 50 stocks each) based on the percentage of revenues that each stock gets from outside of the US. We then calculated the average change in April of the stocks in each decile. As shown below, the decile of stocks with the largest percentage of international revenues declined an average of 4.2% in April. This was by far the worst performance of any decile. Conversely, the stocks that generate all of their revenues inside the US averaged a flat return (0.00%) during the month.
If Europe continues to wither, stocks with heavy European exposure will continue to have a tough go at it.
The Break Down or topping out Stocks like CAT, FDX and PG are only giving me confidence in the view that a fairly dark storm is coming for stocks, not to different than what we saw last year, but we are very likely to be down 5-7% from last months highs at some point in the next month or so.
IBM receives more than 50% of their sales from overseas and about 33% from Europe and the Middle East and about 20% from Asia. I think there is a good chance given IBM’s weak revenue results and red flags of continued weakness even without a meaningful slowdown in Europe, that this stock could be setting up as a great short heading into the company’s estimated mid July Q2 report.
TRADE; IBM ($205) Buy the July 200 / 185 Put Spread for 3.40
-Buy 1 July 200 Put for 5.10
-Sell 1 July 185 Put at 1.70
Break-Even on July Expiration:
Profits btwn 196.60 and 185, make up to 11.60, max gain 185 or lower make full 11.60 (~3.5x your money)
Losses of up to 3.40 btwn 196.60 and 200, and max loss of 3.40 above 200
TIMING OF THE TRADE:
With the SPX down about 2.25% in the last 2 days, it may make sense to wait to initiate this position on an up day in the market.
TECHNICALS: The chart is sitting right on a massive trend line dating back to last summer’s lows when the stock got below $160. Since then it has rallied 23% and it appears that another revenue miss, could send the stock back towards it’s 200 day moving average at about $187.