New Trade CRM – Salesforce Drives Sales, But Where is the Earnings?

by Enis August 23, 2012 3:14 pm • Commentary

New Trade, Aug 23, 2012, 3:15 pm:

CRM is a name that I’ve traded many times in the past couple years.  It’s a volatile stock, with a hopey story, in a hot sector, but nosebleed valuation.  Since the options market is implying a 10% move, it’s just too expensive to buy outright options ahead of the event.  But this stock can move, as evidenced by it’s almost 30 dollar rally in the past 2 weeks.  CRM has made multiple 50 dollar moves back and forth over the course of the last year, in both directions.  And in many cases, it has not been due to any news, but rather the broader market backdrop.  It doesn’t seem like a name where the underlying fundamentals have much short-term impact.  

As a result, it didn’t make sense to play just the earnings event with weekly options.  I liked looking out to October expiry, which gives me 2 months of time, so that even if the reaction to earnings tomorrow is positive, I have a chance that another 50 dollar move down is still possible if the broader market turns.

Looking to October, we talked about put butterflies, such as the Oct 130 / 110 / 90, or the Oct 125 / 100 / 75, for between 2.50 and 3.00.  But if I’m going to risk that much premium, I’d rather just buy the Oct 130 / 110 put spread for 3.50, and have the comfort of knowing that I can make my 20 dollars if the stock sells off substantially without having to thread the needle.

So here’s the trade (with yesterday’s preview below):


TRADE: CRM ($146) Bought Oct 130 / 110 put spread for 3.60

-Bought the Oct 130 put for 5.10

-Sold the Oct 110 put at 1.50

Break-Even on Oct Expiration:

-Profits 126.40 or lower, with max profit of 16.40 at 110 or lower

-Losses up to 3.60 btwn 126.40 and 130, max loss of 3.60 above 130.


Trade Rationale:

I went out to October because if CRM does react positively to earnings, I am still in the game.  On the downside, I think a miss could result in a big move for CRM given its valuation, so I wanted to give myself enough room for a decent-sized profit.




Note:  CRM does not report earnings until after Thursday’s close, but this is an early preview as we start to look at trade ideas

Event: CRM reports fiscal Q2 earnings Thursday after the close.  The options market is implying about a 10% move, which is higher than the 4 and 8 quarter averages of 7-8% historically.

Sentiment: Wall Street analysts are generally bullish on the name, with 33 buys, 2 holds, and 5 sells.  The average 12 month price target is around 174.  Countering that analyst bullishness, though, are short sellers, who are short 10% of the float. What’s a bit surprising is how few changes in ratings the stock has seen despite its very volatile price action in the past year.

Balance Sheet: Salesforce is a very clean company from a financial statement standpoint, as it has few assets and little debt.  It is much more of an income statement growth story, and the whole thesis on the stock is based on what valuation you assign to that growth.

Valuation: This is a classic internet go-go stock, with a tech bubble valuation based on its future earnings potential.  P/E based on fiscal 2013 estimates is around 100, and even for fiscal 2015 consensus earnings estimates of 2.55, the expected P/E is around 60.  I’ve charted Revenue and EBITDA (EPS messy, so I gave them the benefit of the doubt) over the past 5 years.  Revenue growth that eventually translates into earnings growth is the clear hope, since the earnings growth has not been there in the past 2 years.


Price Action:  CRM has been a big winner year-to-date, up more than 40% since the start of 2012.  However, it has had quite a roller coaster over the past couple years, as illustrated by the 3 year chart below:



The stock had been in a steady uptrend until the fall of 2011.  Though the stock did rally in 2012 to make marginal new highs, that turned out to be a failed breakout.  The stock has rallied back with the market in the past few weeks, now near the high end of its 2 year range between 95 and 160.


Volatility: Implied vol across all months is historically high, but not astronomical like a few cycles in the past. It’s higher than the actual vol in the stock and much higher than the historical average of implied vol.

[caption id="attachment_15886" align="aligncenter" width="700" caption="IV30 vs HV30 vs IV360- 2 yr from LiveVol Pro"][/caption]


What is astronomical is the implied vol in the weeklies, due to the fact that they expire the day after earnings. (weeklies in red)

[caption id="attachment_15887" align="aligncenter" width="541" caption="Monthly vol skew from Livevol Pro"][/caption]

What is likely to happen, depending on the direction and size of the earnings move is that the weekly options will quickly go to parity or close to parity about an hour into trading on Friday’s session, while the next months like September and October, which are mid 50s and high 40s respectively will come into the mid to high 30’s. So expect a vol collapse of roughly 25% in those months.

My View: 

Ahead of tomorrow afternoon’s earnings release, we are going to explore many different types of positions.  CRM is a volatile name with a high implied move, and we are looking for a favorable risk/reward trade.  My general bias on this stock is lower, given its premium valuation, lackluster earnings growth, and increasing competition in the cloud sector.  But the trade structure is unlikely to be a flip the coin type of bet.  Rather, the hope will be to benefit from a down move without getting hurt too much if we’re wrong.  Trade post will be tomorrow.