New Trade – The $CSCO Mid

by CC August 13, 2015 1:05 pm • Commentary

CSCO reported better than expected Q4 earnings after the bell last night:

The company’s adjusted profits rose 7 percent to 59 cents a share, while revenue increased about 4 percent to $12.8 billion. Wall Street expected earnings of 56 cents a share on $12.65 billion in sales. It also handed in first-quarter earnings and revenue projections that were in line with expectations.

The stock is up over 4% today on the news, which for now is below the implied move of about 5.5%, but in line with the 4 qtr avg of about the same. I guess the most important take-away in our minds is that there were no surprises in the first quarter under new CEO Chuck Robbins, and that the company is executing well on their ongoing transition in the face of headwinds that include weak emerging markets and US dollar strength.

CSCO has an interesting chart in 2015, if you’re interested in stocks going sideways for months on end. The stock has spent the bulk of the year where it started, around $28 and has only made moves up and down by a few dollars with lows on the year near $26 and highs near $30:

Screen Shot 2015-08-13 at 10.13.53 AM
1 yr CSCO from LiveVol Pro

That lack of direction has recently resulted in a convergence of its moving averages around that $28 level and makes it a good candidate for a range trade and possible defined risk income play…

We want to center the trade at that $29 level. We’d prefer fading this earnings move a bit but the strikes in September are a dollar wide and centering the trade at 28 gives us a breakeven just too tight to where the stock is today. With the 29 center the trade starts out in the money with a breakeven higher than what should be resistance if the stock continues higher to $30. A breakout above 30 seems to be the major risk on this trade. But even if it went sideways or even slightly higher the trade would still be profitable:

Trade – CSCO ($29) Buy the September 31/29/27 put fly for .85

– Buy 1 Sept 31 put for 2.10

– Sell 2 Sept 29 puts at .70 (1.40 total)

– Buy 1 Sept 27 put for .15

Breakevens on September expiration:

Gains: of up to 1.15 between 27.85 and 30.15 with max gain of 1.15 at 29

Losses: of up to .85 below 27.85 and above 30.15 with loss of all .85 below 27 and above 31.

Rationale – CSCO stock hasn’t shown any indication of being able to breakout to new highs and it seems to have found buyers on better than expected earnings which makes it unlikely that any significant breakdown happens without a broader market correction. This trade plays for continued sideways action with a breakeven on the upside near recent highs and one on the downside near recent lows. The trade is short vega with vol at about 20 in September. 20 is typically where implied vol is right after earnings but it also tends to go down a few more points in the days after with lows closer to 16. If that happened again that would be positive for the trade. On the defensive management side of this trade we’d likely close it for a loss if the stock made moves outside of that range.