Name That Trade – $CSCO: Robbin’s Hood

by Dan October 23, 2015 3:47 pm • Commentary

Shares of MSFT are up an astounding 11% today, breaking out to new 15 year highs. The chart now shows little overhead resistance until its prior all time high just below $60 back in 1999:

MSFT 15yr chart from Bloomberg
MSFT 15yr chart from Bloomberg

Which brings me back to some comments I made about CSCO on Wednesday (here):

Looking past CSCO expected fiscal Q1 report on November 12th, it’s hard to ignore the vigor of the new CEO, the company’s propensity for cash return which last year equaled almost $9 billion, or 70% of their free cash flow and the fact the stock trades 12x earnings, well below a market multiple.  Oh, and the 16 year chart below shows what has been a long dirt nap for the stock as it has spent the better part of the post area between the mid teens and the high $20s:

CSCO 16 year chart from Bloomberg

The stock is clearly threatening a breakout of epic proportion, and if the company were able to report inline and guide up, a 3 handle is coming to a theater near you. That said a $28.50 long entry after the stock’s recent run is not advisable.

The last sentence is what I want to focus on.  It seems like in just two days the investment world has turned upside down, from one of cautious optimism, to outright euphoria.  And to be frank, I have been cautiously optimistic on CSCO for a while now, which may mean it is right to finally pull the trigger.  Here is the thing, the stock is very cheap relative to most if not all mega-cap tech peers. Like MSFT they have a new CEO who is looking to right his own script for the company they inherited, have a killer balance sheet, committed to massive levels of cash return.  CSCO’s exposure to emerging markets could be a problem if we don’t get an uptick in global growth anytime soon, and the recent bounce of the dollar is likely to pose no shortage of headwinds to forward guidance, but it seems for now investors are looking past know headwinds.

IN the post from Wednesday I laid out a bullish risk reversal as a way to play for a breakout in the near year in CSCO. The idea of short puts to buy calls makes a lot of sense for those willing to be put the stock in the event of a market meltdown like we had in August, or in the event of a stock specific disaster like we had earlier in the week in VmWare (VMW).

I want to channel my pre-MSFT earnings post and lay out a new trade in CSCO for similar reasons for the one I laid yesterday:

For those who want to play for a breakout, you may want to consider the following trade:

Bullish: MSFT ($48.75) Buy Jan16 50 call for $1.35

Rationale: longer dated options look dollar cheap, and if the stock is set to breakout above the recent range there is plenty of room to run, and it could go for a while. I would look to spread these long calls on a move above the strike.  Risking less than 3% of the stock price.

But sometimes it makes sense to just keep it simple, risk what you are willing to lose and get in the game:

Potential Trade: CSCO ($29.20) Buy Feb 30 call for $1

Break-Even on Feb Expiration:

Profits: above $31, up 6%

Losses: up to $1 between 30 and 31, max loss of $1 (or 3% of stock price) at 30 or below

Rationale: I’m not pulling the trigger on today’s euphoria but this simple trade makes sense on a slight pullback for those that want to play for a breakout. Options prices are  not exactly cheap, but these fairly near the money calls capture two earnings events, and if I were to get a move through the long call strike it would give me the opportunity to spread the call by selling a higher strike call in the same expiration, reducing my premium at risk.