Name That Trade – How Soon is $NOW

by Dan April 16, 2015 2:31 pm • Commentary

Event: After the close tonight ServiceNow (NOW) will report their Q1 results. The options market is implying about an 8% one day move, which is a tad higher than the 7.7% average over the last 4 quarters.  

Valuation: The enterprise cloud service provider has had a heck of a run, already up 22% in 2015, and up 88% from the 52 week lows made last April.  That sort of performance comes at a price. The company’s $12.5 billion market cap, which places the stock at 12.5x expected 2015 sales of about $1 billion.  By now, at this stage of the bull market, we know better to short stocks on mundane things like valuation, especially for a company like NOW which is well placed in one of the largest secular computing changes in decades (cloud computing and SaaS).

Technicals / Price Action: From a technical standpoint, the stock over the last year has made a very systematic set of higher highs and higher lows, with the stock now seemingly breaking out to new all time highs after its third multi-month consolidation in the last year:

[caption id="attachment_52847" align="aligncenter" width="600"]NOW 1yr chart from Bloomberg NOW 1yr chart from Bloomberg[/caption]

Vol Snapshot: With the stock’s steady incline over the last year, options prices have been steadily moving in the other direction. This is a function of the stock’s price action but also a reflection of the broad market’s lack of volatility:

[caption id="attachment_52848" align="aligncenter" width="600"]NOW 1yr chart of 30 day at the money IV from Bloomberg NOW 1yr chart of 30 day at the money IV from Bloomberg[/caption]

Open Interest: Total options open interest is 62,000 contracts, fairly evenly split between calls and puts, with two strikes making up two thirds of the total: 21,600 of the Jan 90 calls, and 18,500 of the Jan 70 puts.

My View: Great story, and could be a take-over candidate for a company like Oracle (ORCL). Despite the fact a deal with a 30% premium from current levels would be eye-popping in terms of valuation, it could be the quickest way for them to overtake the leader in the space Salesforce (CRM).  That being said, its hard to chase a stock for reason as unlikely as a take-over and at its current standalone it will be very hard for the stock to maintain current valuation levels when the sales and bookings growth decelerates in a meaningful way from last year’s 60% sales growth.

If you are inclined to play for a continuation of the momentum and think the stock could be up in line with the implied move (about $6.50), then you might want to consider the following bullish trade:

NOW ($82.87) April 85/90/95 call butterfly for .95

– Buy 1 April 85 call for 1.80

– Sell 2 April 90 calls at .45 each or .90 total

– Buy 1 April 95 call for .05

Breakeven on April Expiration (Tomorrow): Loss of .95 at $85 or below. Gains of up to 4.05 between 85.95 and 93.95 with max gain at $90. Losses of .95 above $95.

Rationale – This is a very binary trade with only one day until expiration. But this is also the least expensive way to play for a breakout. The chances of this blowing through the short strike are pretty slim, but there is that risk. The most likely risk is it is instantly worthless on a down or sideways-ish move on earnings.

We’re not doing this trade as we have no conviction on the name but this is the type of chart that’s been breaking out lately, so if you’re involved in the name this trade may interest you.