Name That Trade – $BRCM Break or Fake

by Enis February 21, 2014 7:29 am • Commentary

We first looked in depth at BRCM in early December, after the stock broke out of a multi-month base on decent volume.  That technical breakout and the stock’s relatively cheap headline valuation led us to take a more detailed fundamental look at Broadcom.

The conclusion in our Deep Dive post was mixed:

Those 2 points are enough reason for me to keep an eye on BRCM stock, but not enough to consider it as a potential long opportunity (except for maybe a technical trade) at any point in the near future.  The company has to show that its business write-offs are behind it, with a clean slate and innovation ahead of it.

The two points for optimism were the stock’s valuation and the experienced management at the helm.

Since that post, BRCM has risen about 10%, holding both the $28 breakout from December, as well as moving above the longer-term $30 resistance level:

BRCM daily, 150 day ma in yellow, Courtesy of Bloomberg
BRCM daily, 150 day ma in yellow, Courtesy of Bloomberg

The stock has almost filled in the gap from its July earnings report, when it announced the large write-off of its NetLogic acquisition.  

On the most recent earnings update on January 30th, BRCM slightly beat earnings expectations, and guided in line for the first quarter of 2014.  Overall, however, the business remains somewhat stagnant, even as the stock has risen from depressed levels over the past 6 months.  Analyst expectations for the first quarter earnings number are 0.45, which would be the lowest quarterly earnings figure since September 2009.

Meanwhile, implied volatility in BRCM has declined to near 2 year lows, into the low 20’s:

[caption id="attachment_36602" align="alignnone" width="600"]BRCM 30 day implied volatility, Courtesy of Bloomberg BRCM 30 day implied volatility, Courtesy of Bloomberg[/caption]

BRCM’s grind higher has reduced realized volatility in the past few months, so options traders have lowered expectations for future volatility.  With the $30 pivot level an important long-term technical spot, we might look at a long volatility strategy if the stock returns to that level.  A long straddle position might be attractive to play for either a more powerful breakout above $30 after a retrace, or a failed breakout, leading to a fast move below $30.  The low analyst expectations for the upcoming quarter (which will be reported in late April) could lead to more aggressive positioning by traders and investors ahead of the event, another source of potential volatility.

We rarely pay outright premium for a position with no directional bias, but this setup might be one of the rare situations where risk/reward might merit a look.  The March 30 straddle is priced at around $1.80, while the May 30 straddle is priced at around $3.25, though both would be a bit cheaper if the stock did retrace to the $30 level.  April options will list soon as well, which would not capture earnings, but give us more time for the technicals to play out than a March position.

Doing nothing for now, but wanted to lay out our broad thoughts given the fundamentals, technicals, and volatility situation.