Trade Update June 20th, 2013: earlier this week NTAP made a new 52 week high, quickly approaching the sweet spot of what was an in the money call butterfly prior to the company’s fiscal Q4 earnings about a month ago. With the stock pulling back from the highs and the broad market having a decidedly different feel to it, I am going to close this bullish position for a gain and look to re-initiate this view with the stock back towards the recent break-out level of about $36.50.
ACTION: Sold to Close NTAP ($38.27) the Jul 35 / 40 / 45 Call Fly at 2.25 for a .77 gain.
Original Post May 21st, 2013: New Trade $NTAP – Cash Hoard & Potential Distribution Overriding Poor Fundamentals?
I laid out all the angles on NTAP in the earnings preview post earlier today, included below. This is a boring “cheap tech” stock in an unloved area, with the main excitement in the name surrounding the involvement of Elliot, a savvy value fund with a long battle ahead of it.
If we weren’t options traders, we wouldn’t touch this stock ahead of earnings. We have little interest in buying it given the fundamental headwinds and the poor business backdrop ( just yesterday the stock was downgraded by brokerage firm R.W. Baird read here, things seem dicey at best at the moment). But the options setup is more interesting. With an activist involved, and the relatively cheap valuation, the downside in the name is likely limited. We’re less excited about the potential upside. So we’re going with a classic trade structure that has worked on lukewarm situations in the past.
TRADE: NTAP ($36.40) Buy the Jul 35 / 40 / 45 Call Fly for $1.48
- Buy 1 NTAP Jul 35 Call for 2.77
- Sell 2 NTAP Jul 40 Calls at .71 each or 1.42 total
- Buy 1 NTAP Jul 45 Call for .13
Break-Even on July Expiration:
- Profits of up to 3.52 btwn 36.48 and 43.52, maximum gain of 3.52 at 40
- Losses of up to 1.48 btwn 35 and 36.48 and btwn 43.52 and 45, with max loss of 1.48 at or below 35 and at or above 45
Trade Rationale: Enis initiated a similar call fly on QCOM ahead of its earnings report last month. The stock actually sold off on a bigger than expected-move, and if we had on a simple long delta options trade, we would have been deep in the hold from the get-go. But the call fly held its value much better because of its short vol bias into an earnings event, and Enis was able to exit the trade for almost flat on the first rally in QCOM (posted here). The trade would now be a solid winner if Enis had stayed in it, despite the fact that QCOM is actually lower than where Enis initiated the long call fly. I bring all of that up to say – I don’t have a ton of confidence that the stock goes higher from here, but the long call fly structure is a great risk/reward way of taking advantage of high pre-earnings vol for this type of situation.
Earnings Preview May 21, 2013:
Event: NTAP reports their fiscal Q4 earnings tonight after the close. The options market is implying ~6.75%* move post results which is essentially in line with the 4 qtr avg move of ~6.94% and the shy of the 8 qtr avg of ~8.5%.
*The weekly at the money straddle is offered at ~$2.50 or ~6.7% of the underlying stock price, so if you bought that you would need a $2.50 move in either direction by Friday’s close to break-even.
Sentiment: Wall Street analysts are fairly mixed on the stock with 15 Buys, 22 Holds & 2 Sells with an avg 12 month price target of ~$38.30, or about 2.5% higher than current levels. Short interest sits at ~5.5% of the float. The top 10 Holders, own about 38% of the shares outstanding.
Options Open Interest: Call to put ratio of open interest is around 1.2 to 1, but recent volumes have been heavily skewed to the calls side, with the recent 10 day average ratio above 2 to 1 skewed to calls. The bulk of open interest is in June and September, spread among the strikes ranging from 32 to 40, the range that the stock has been in all of 2013.
Volatility Snapshot: Vol is not high historically and Implied vol and Actual vol have converged recently. June vol is about 40 and will come into the low 30′s following the event. Here’s how IV30 bs HV30 looks historically with earnings events marked with a E:
from LiveVol Pro
Price Action / Technicals: On a long-term chart, NTAP is a stock that went from a steady uptrend in 2009 and 2010, to a steady downtrend in 2011 and 2012. Here is the 5 year weekly showing what I mean:
5 year weekly chart of NTAP, Courtesy of Bloomberg
Its recent rally ended the 2 year downtrend, but it’s less clear whether this is the start of a new uptrend, or just a time for consolidation.
There are several reasons for optimism on the 1 year daily chart. First, the stock recently made a new 52 week high, breaking above the 37 level (red line) on strong volume on the Elliot news:
1 year daily chart of NTAP, Courtesy of Bloomberg
Second, the volume in the past month has picked up, mostly on up days, shown by the green oval in the lower panel. Buyers are getting more aggressive. Finally, the 200 day ma held as support in April, and is now turning higher.
The 37 area is critical support, and the key level to watch going forward.
Expectations: After the Elliot news hit the tape, it was rumored that NTAP hired Goldman Sachs to advise them on their “options”. GS equity research rates the stock Neutral with a $32 12 month price target. IN their quarterly preview dated May 15th, GS had the following to say about the qtr:
we expect shares to remain range-bound unless NetApp can solve three key concerns, namely:
1) the company needs to clearly outline a plan to adjust its sustained operating expense levels for what appears to be a slower pace of sustained revenue growth,
2) as a more mature technology company with steady cash flow generation, the company should outline how it plans to be more aggressive with its capital allocation activities (buybacks and dividends in particular), and
3) the company should assuage investor fears that it will become overly aggressive with future M&A actions in a bid to chase growth.
While NetApp appears to have made some progress on these fronts in recent months, it is not yet clear that the company has adjusted to the current phase of its corporate lifecycle (i.e., the shift from a hefty growth story to a slower-growth, cash-flow centric company).
MY VIEW: NTAP doesn’t exactly fall in the “cheap old Tech” category trading at 14x next years expected earnings, with a modest share buyback and no dividend, it is hard to make the argument that near term weak fundamentals can be offset by financial engineering. Unfortunately given the recent results from RAX and VMW don’t exactly scream getting in front of what could be a drawn out process as investors try to replace some of the board and effect change. As for an acquisition target it has been rumored for years, but it appears that large IT vendors like ORCL, CSCO and IBM are looking more towards cloud plays. We don’t love the idea of playing in front of earnings as we expect mediocre results and guidance, and the company likely to suggest that they will be exploring all ways to enhance shareholder value without making any specific suggestions.