New Trade $IBM: Too Far Too Fast

by Dan May 3, 2013 3:34 pm • Commentary

Here is a summary of what I will be discussing tonight on Options Action on CNBC at 5:30pm:

IBM reported a weak Q1 back on April 18th and offered guidance that caused the street to reduce their full year estimates.  The whole enterprise tech space has actually been a disaster during this earnings season.  ORCL had its largest down move in years, and IBM was not long to follow.  Here’s what GS research said about IBM specifically:

IBM reported disappointing first quarter results, with revenues and EPS both falling short of our estimates and consensus. While we had expected the counter-cyclical components of IBM’s portfolio and the current mainframe cycle to enable the company to overcome currency pressures and weakening demand trends as the quarter progressed, the push out of software and mainframe transactions into the second quarter drove the rare earnings shortfall (the last was in 2005).

From a segment perspective, all of the segments fell short of expectations, with the most significant shortfall coming from hardware.

With its disappointing results, IBM joins the list of enterprise software, networking and services companies that have raised investor concerns over the tone of IT spending in 2013 and this is clearly a worrying sign for the rest of the enterprise sector. Similar to comments made by other companies, IBM noted a deterioration in business conditions after a solid month of January.

The miss was in all geographies, in all segments.  If you told me before the earnings report that I could get a chance to sell the stock at 205 after a report like that, I would be thrilled.  Well, here we are, back at 205, and the technical setup looks weak.

The chart of IBM since the start of 2012 shows a stock that tried to break out in March and April, and quite simply, failed:

Daily chart of IBM in 2012 and 2013, courtesy of Bloomberg
Daily chart of IBM in 2012 and 2013, courtesy of Bloomberg
The 2 red circles denote the gap lower in April 2012 and the gap lower after earnings in April 2013.  In 2012, the stock rallied back to almost fill the gap, but in fact was unable to do so.  This time around, the stock has also rallied to almost fill in that important gap around 207, but it has failed to do so.  More importantly, the gap lower after earnings was on huge volume (circled in green), lending more credence to the aggressiveness of sellers, which often leads to lower prices after a retrace higher like the one we’ve seen.
TRADE: IBM ($204.85) Bought June 205/195/185 Put Fly for 2.25

-Bought 1 June 205 put for 4.85

-Sold 2 June 195 put at at 1.55 each of 3.10 total

-Bought 1 June 185 put for .50

Break-Even on June Expiration: 

-Profits btwn 202.75 and 187.50, make up to 7.75, max gain of 7.75 at 195

-Losses of up to 2.25 btwn 202.75 and 205 & btwn 187.50 and 185, max loss of 2.25 above 205 and below 185

Payout Diagram:

Screen Shot 2013-05-03 at 1.02.50 PM
from TradeMonster

Trade Rationale:  The stock rallying back to near its pre-earnings level is a great short setup, especially with a defined risk trade like the butterfly that is a 20 delta short position that will hold its value if the stock does not go down immediately.