We previewed HPQ’s fiscal Q4 earnings release yesterday morning. Our key takeaway from that preview:
HPQ is one of the best performing hardware stocks of 2013. That strong outperformance is largely a function of dismal performance in 2010, 2011, and 2012. With the stock’s P/E close to 10, combined with the secular headwinds that the company faces, a range bound situation between $20 and $28 over the next 3-6 months seems the most likely outcome.
While we are skeptical about the company’s prospects in the long-run given the lack of investment, the short-run picture looks more mixed. HPQ has been locked in a bull/bear battle for the past 6 months, with no clear winner. Bulls continue to tout the cheap valuation argument, while bears view the valuation as distorted by accounting gimmicks, and the business prospects as poor to very poor.
Add it all up, and here’s our trade ahead of the earnings report after the close:
TRADE: HPQ ($25.23) Buy Dec21st 28/25/22 Put Fly for $1.10
- Buy 1 Dec21st 28 Put for 3.20
- Sell 2 Dec21st 25 Puts at 1.17
- Buy 1 Dec21st 22 Put for 0.24
Break-Even on Dec21st Expiration:
- Profits of up to 1.90 between 23.10 and 26.90, with max profit of 1.90 at 25
- Losses of up to 1.10 between 22 and 23.10 and between 26.90 and 28, with max loss of 1.10 below 22 or above 28
Trade Rationale:
HPQ has traded between 20 and 28 for the past 6 months. HPQ’s strong guidance for 2014 in early October was the catalyst for the stock’s most recent, 1 month bounce from 20 to 26.50. Since that news is already in the stock, the novelty of today’s earnings report is reduced. While that is reflected in the lower-than-normal implied move in the options market for HPQ earnings (7.5% vs. over 10% moves in each of the past 4 quarters), we view the likelihood of a break higher or lower as greatly reduced nonetheless.
The range trade centered around 25 is based on the August high of $27.77, and the rising 50 day and 200 day moving averages in the $23 – $23.50 area. The main risk that we see is on revised guidance materially different from 6 weeks ago (either better or worse). While we don’t expect that given Meg Whitman’s generally conservative stewardship, that could put this trade in the losing column quite quickly.