Cisco (CSCO) is a stock that we haven’t traded a whole heck of a lot lately because it hasn’t done a whole heck of a lot for the last year, trading between $21 on the downside and current levels near $25:
Over the last 6 years the stock has traded in a wider range, but spending most of the period at the lower half of the range:
Back in late March, when CSCO was just below $22, I made similar argument (read here) that I am going to make now, that despite what amounts to anemic expected sales and earnings growth, the stock is attractive because it has a massive cash balance, a commitment to cash return (stated policy for capital allocation “return a minimum of 50% of our free cash flow annually through dividends and share repurchases” currently 3% dividend yield and $4 billion worth of stock bought back in fiscal Q2 and $2 billion in fiscal Q3), geographic reach and rock bottom valuation (trades 11.5x next years expected earnings, VS INTC and MSFT at 14.5x.) Since I first made the argument, CSCO has rallied about 10%, which represents much of its year to date gains. But the stock still lags many of its old tech peers like INTC and MSFT which have both made new 14 year highs, while CSCO is till 27% below its 2007 high.
My largest concern with CSCO is the lack of expected growth, analyst expect earnings and sales to only grow about 5% in the current fiscal year, which is essentially in line with that of most mega cap tech peers, but for some reason CSCO trades at a healthy discount.
Just as was the case in March, when I made an out of the money bullish bet targeting their next earnings event as a catalyst, option prices are cheap, making directional bets, even in this low vol environment, palatable. The two year chart below of CSCO implied vol shows the very recent spike off of multi-year lows, largely the result of some hefty call buying today. Total options volume today is already running 2x avg daily volume with 50,000 of the Sept 27 calls trading between .16 and .22 in what looks mostly like a single buyer.
Two year chart of 30 day at the money IV from Bloomberg:
While I don’t love the idea of entering new longs at current levels, I think CSCO’s recent consolidation, combined with what amounts to very low expectations sets up for a big catch up move to some of its peers on the slightest bit of good news when the company reports their fiscal Q4 report in Mid August.
The bullish trade that I am going to make is very different than the one described above, as I am going to look to a trade that has a greater probability of success due to its lower break-even and take-advantage of the today’s spike in vol of the line that is being bought in good size today.
New Trade: CSCO ($24.87) Bought Sept 25/27 Call Spread for .56
-Bought Sept 25 call for .78
-Sold Sept 27 call at .22
Break-Even on Sept Expiration:
Profits: between 25.56 and 27 of up to 1.44, max gain of 1.44 above 27
Losses: between 25.56 and 25 lose up to .56, max loss of .56 below 25
Rationale: This structure gives me very near the money participation in the event of a breakout, but caps gains just above the 52 week highs of $26.48 made last August. I also like selling the Sept 27 calls as they have seen a nice one day pop due to today’s buying. If the stock bounces to 26 this trade should be a double, which is in contrast to what this morning’s buyer is looking for (more like a home run.) With realized vol relatively low I still like spreading as the next month could see a continuation of the consolidation and I want to at least help offset a little decay in the 25 line despite the fact that IV is likely to continue to go up into the earnings event.