New Trade – $CSCO: Network Lag

by Dan March 20, 2014 2:45 pm • Commentary

Old tech is having a bit of a resurgence of late.  MSFT just broke out to new 14 year highs, up 8.3% on the year:

MSFT 14 year chart from Bloomberg
MSFT 14 year chart from Bloomberg

HPQ is up 12% in the last week, and up 15% on the year making new 2 and half year highs:

HPQ 3year chart from Bloomberg
HPQ 3year chart from Bloomberg

EMC is up almost 20% from the 2014 lows, up 10.5% on the year and breaking out to new one and a half year highs:

EMC 2 year chart from Bloomberg
EMC 2 year chart from Bloomberg

Whats consistent about these three stories is that all were once great tech leaders, all are fairly cheap on a valuation basis, and all had fairly poor sentiment as it relates to their businesses, despite the solid stock performance.  

One other Ol Tech name that have lagged the broad market and its peers, CSCO, could be ready to join the party.

The two year chart of CSCO clearly displays its laggard status, and based on the commentary from the company’s February earnings call, the fundamental situation seems strained at best.  Throw in the company’s exposure to emerging markets and maybe there is good reason for the lack of buy interest.  The stock pays a dividend that yields almost 3.5%, has a monster buy back, 25% of their market cap in cash (net of debt) and trades at just 10.4x next years expected earnings.  But maybe for good reason, analysts expect earnings to decline in low single digit percentages this year on a sales decline of about 5%.

That being said the stock seems poised to run on the slightest bit of good news.   The one year chart below, shows the stock sitting on important near term support (red line), while $23 would be the target for a short term pop and $24 the level to possibly short:

[caption id="attachment_37795" align="aligncenter" width="589"]CSCO 1yr chart from Bloomberg CSCO 1yr chart from Bloomberg[/caption]

Oh, and implied vol is nearing multi-year lows, meaning options are cheap for those looking to express directional views.

[caption id="attachment_37796" align="aligncenter" width="589"]CSCO 2yr chart of 30 day at the money IV from Bloomberg CSCO 2yr chart of 30 day at the money IV from Bloomberg[/caption]

The next identifiable catalyst will be fiscal Q3 earnings in Mid May.  May at the money options are about a 22 vol, a bit elevated from 30 day in highs teens, but if the chart above holds, May options that catch earnings should rise at least to  mid 20s or possibly low 30s offsetting some decay.

In this case I am going to simply buy calls with the intent to spread on the first move higher.  I am not expected positive fundamental news in the time period and frankly don’t expect a turnaround.  This is a sentiment and momentum trade.

TRADE: CSCO ($21.88) Bought May 22 calls for .63

Break-Even on May Expiration:

Profits: Above 22.63 have unlimited profits.

Loses: Between 22 and 22.63 lose up to .63, below 22 lose full .63

Rationale:  Sentiment poor, peers are ripping, stock is cheap, and options are ripe for directional players… as most of you know, we are Playas, we like the set up.