Name That Trade – $IBM: Blue’s Clues

by Dan October 19, 2015 12:24 pm • Commentary

Last Monday we took a look at IBM following the announcement of DELL and EMC’s intention to merge.  While IBM could be a candidate to split some its faster growing cloud based businesses from their slower growth legacy businesses like HPQ is set to do on November 1st, it is our sense they are more likely to be acquisitive to stimulate revenue growth, but:

Investors in IBM would not take too kindly if the company added to their $38 billion ($30 billion net of cash) in debt (25% of their $148 billion market cap) to do a mega deal. I suspect investors would rather see a HPQ sort of split, or a scenario not too different to when GE sells off non-core assets and uses the proceeds to buy back stock.  IBM had been using most of its free cash flow to buyback shares and pay its dividend (prior to this year), but has since cut its buyback as the company is expected to have its first 10% plus sales decline (this year) in more than a decade.

What about an acquisition in a fast growing cloud based business for IBM, or security software? I suspect the expense would be prohibitive for a large deal like SalesForce (CRM). And a smaller deal like Palo Alto Networks (PANW) would not move the needle for years on their $83 billion in expected sales.

I have no clue what IBM is going to do strategically, I suspect just continued inertia.

Event: The company reports Q3 results tonight after the close. The options market is implying about a 4% one day move which is a tad shy of their 4 qtr avg of about 4.25% and the 10 year avg one day move of about 3.5%.

Last week we got negative data points regarding enterprise hardware demand, specifically from chip-maker Intel (INTC) in their forward guidance pointing to servers and in a negative pre-announcement from hard disk drive manufacturer Seagate (STX), which spoke to weak demand for large capacity nearline storage drives.

Price Action / Techncials: IBM is down 7% on the year, and down 13.5% from the day of its Q2 report on July 20th.  The stock is now just below a recent technical support level at $150, with the obvious downside target of $140, the recent low, and $160 on the upside, which corresponds with the stock’s 200 day moving average:

IBM 1yr chart from Bloomberg
IBM 1yr chart from Bloomberg

On a longer term basis, its apparent that IBM is a broken stock, having  made all time highs back in 2013, and then having broken the uptrend that had been in place since its lows in 2008.  $140 is a massive technical support level with little support to $120.  An ideal short entry would be closer to the downtrend near $160, which is also its 200 day moving avg:

IBM 8 year chart from Bloomberg
IBM 8 year chart from Bloomberg

Vol Snapshot:  Options prices have remained bid since the August market swoon, now very near levels prior to the last 4 earnings reports at multi year highs with implied volatility at about 24%:  

[caption id="attachment_57724" align="aligncenter" width="600"]IBM 1 year chart of 30 day at the money Implied Vol from Bloomberg IBM 1 year chart of 30 day at the money Implied Vol from Bloomberg[/caption]

Our Take: Barring some sort of corporate strategic action I see little reason to buy a stock like IBM at this stage of the game.  We are in a market where you stick with longs that are working and sell rallies on stocks that have shown relative weakness. IBM falls into the latter group.  We are not of the mindset to press a short like IBM so far below its downtrend, but also recognize that a miss and guide lower and the stock is probably right back in the low $140s.  If the quarter and guidance are in line and the company were to announce some sort of strategic corporate action than the stock is in the high $150s.

Potential Trades: If I were inclined to play for the latter, a bounce to $150, I would consider the following trade:

Bullish: IBM ($149.40) Buy the November 152.50/160 call spread for 1.85

Rationale – this trade defines risk to 1.85 with the potential of profits up to 5.65 on a move back to 160 or above on November expiration.


If I were inclined to play for further and expected disappointment for a move back to $140, I would consider:

Bearish: IBM ($149.40) Buy the Oct22 weekly 148/140 put spread for 2.00

Rationale – This trade defines risk to 2.00 for a move back towards recent lows. It has the potential for up to $6 in profits and uses the weeklies as if it happens, a move towards lows is likely to come on the report itself.

AGAIN WE LACK CONVICTION ON DIRECTION TOMORROW, and as always we will offer our usual disclaimer about long premium event trades, you need to get a lot of things right to just break-even, like direction, timing and magnitude of the move.

We would be more inclined to short the stock after results if it were up in the high $150s on some sort of BS restructuring.