Name That Trade – $ADBE: That Looks Shopped

by Dan March 16, 2015 1:25 pm • Commentary

Event: Adobe (ADBE) reports their fiscal Q1 results tomorrow after the close, the options market is implying about a 5% one day move which is shy of the 5.8% 4 qtr avg move.  Over the last 10 qtrs the average one day move has been around 6.5%, with 8 moves higher that have averaged 7.35%, while the two moves lower have averaged about 3%.  

Price Action/ Technicals:  despite closing very near its highs of 2014, up 24%, the stock was very volatile, trading between the high $50s and the mid $70s. All that culminated with a failed breakout in mid December:

[caption id="attachment_51982" align="aligncenter" width="600"]ADBE 1yr chart from Bloomberg ADBE 1yr chart from Bloomberg[/caption]

The stock has since successfully made new highs and for now appears to be establishing a new range above the prior highs.

My View:  ADBE trading at 38x expected 2015 eps of about 2.10, and 8x expected sales of a tad less than $5 billion is far from cheap for a software company with a $40 billion market cap.  The shares fairly adequately capture a bit of the enthusiasm associated with their ability to rapidly grow subscribers for their Creative Cloud suite.  In December the company guided Creative Cloud subs to about 5.9 million vs the consensus of 5 million, which was massive, the issue here is whether or not they will be able to maintain pricing.  Regular readers know that I don’t exactly get the valuation re-set for a stock like ADBE that had ceded earnings in their endeavor to migrate to a software as a service model.

The stock is obviously priced to perfection, but the likelihood of a big miss is not great given their guidance in December, and some of the read throughs from other large software vendors like CRM of late.  As far as surprises, the company has already announced a new $2 billion share repurchase in mid January (here) but given that a more than 50% of their sales come from outside the U.S., the strength of the dollar could weigh on results and guidance as the DXY (dollar index) is up 13% since mid December when they last gave guidance.

Hypothetical Trades:

To play for a bullish move, isolating the event itself, the March 80/95 call spread around a dollar seems like good risk reward. This is very binary with a strong likelihood of losing everything balanced by the possibility of making more than a double.

For a bearish longer term view (this also works as a hedge against long stock) the July 75/65 put spread is about 2.50. That’s decent but we don’t feel compelled to get involved just yet on the short side but that gives some time and probably doesn’t get destroyed if the stock is flat or up slightly following the event.

An interesting range trade isolating a move back to the prior highs around $80 is the March 77.5/80/82.5 call fly at around .60. That’s basically like buying the stock here (intrinsic entry of 78.10) with only .60 of risk. However, a move through $80 and the profits start to trail off with a loss of .60 above $82.5 in the stock. So it’s threading the needle a little bit but has pretty good odds of being a winner if the stock doesn’t go down.