Trade Idea(s) – $NOW, $ORCL & $WDAY

by Dan December 16, 2015 1:57 pm • Commentary

Last week I previewed Oracle’s (ORCL) fiscal Q2 earnings report due out after the close (here). With just a few hours to the print, the options market is implying about a 5% move between now and Friday’s close.  With the Stock at $38.50, the Dec 18th 38.50 straddle is offered at about $1.95, if you bought that you would need a move up to $40.45 or down to $36.55 to just break-even.

It’s my sense that this is a fairly important quarter and guidance for ORCL as investors were fairly disappointed with the miss on Cloud software sales (SaaS and PaaS) back in mid Sept and guided down for the current quarter. If the company were to miss the lowered forecast and guide down again then the stock, which has massively under-performed mega-cap tech peers this year (down about 15%), would likely find itself re-testing its 52 week lows (in the mid $30s) into year end.

If this were to occur, the question will quickly turn to how to fix their cloud offerings and stimulate growth. Per my Dec 3rd note:

Organic growth has been hard to come by, and they are obviously stumbling a bit with their cloud transition. But ORCL is a roll up for all intents and purposes, and I suspect ORCL is going to be forced to make a large acquisition and soon to help stimulate growth. Which is has long been their plan. Dating back to their $10 billion purchase of PeopleSoft in 2005, the company has made a bunch of smaller, but still very large purchases (Siebel for $6 billion in 2006, Hyperion for $3.3 billion in 2007, BEA Systems for $8.5 billion in 2008, Sun Micro for $7.4 billion in 2010, RightNow for $1.5 billion in 2011, Taleo for $1.9 billion in 2012, Acme Packet for $2.1 billion in 2013, and Micros for $5.3 billion in 2014). You get the point, any and all sales growth in the last decade has come from acquisitions.

The answer becomes obvious, they would need to deploy some capital, beef up their cloud offerings and associated revenues.

With nearly a third of their $165 billion market cap in cash the company could make a large transformative deal, but their debt load has more than doubled since 2013 and investors could soon become worried about leverage ratios if future deals are expensive and don’t deliver. CRM is probably way too big, but maybe Service Now (NOW) or Workday (WDAY) both with an expected $1.3 billion in sales next year, with expected sales growth of about 35%, both with market caps around $15 billion. A deal would likely be at $20 billion for either.

So What’s the Trade?

Just buying upside calls in the hopes of a breakout move is a good way to lose money over time. So in stocks that you feel could start having their names thrown around as possible takeouts, you want to finance the purcahse of upside calls. Both WDAY and NOW report earnings after the January expiration cycle, which means a sale of an upside call in Jan to buy farther out makes sense. We’re not ready to pull the trigger on either at the moment as we’d like to see how each stock ends 2015 but if we did we’d likely look to a similar trade for both, risking about the same amount of premium. The NOW Jan/Feb 90 call calendar is 2.25 and WDAY Jan/Mar 85 call calendar is 2.60. Both those trades sell January to finance a month the catches earnings and both risk 2-3% of the underlying to positon for unlimited upside after January.

The other way to play is zero cost risk reversals. This is a much more bullish way to play and of course has much bigger margin issues. Risk reversals are for those willing to buy the stock lower and maybe unsure about exact entry. They protect against small moves lower in the stock while keeping unlimited upside above the long call strike in case of a massive move higher.

-The NOW Feb 75/95 risk reversal is a even money (vs $85.40, selling 1 Feb 75 put at about $2 and buying 1 Feb 95 call for about $2)

-the WDAY March 70/90 risk reversal (vs stock at $79.81, selling 1 March 70 put at 2.45 and buying 1 March 90 call for 2.35) is a small credit..

These trades need to be treated much more like stock and therefore entry is critical. If the broader market were to see some selling this is a good trade to scoop a stock on your list and get better strikes than today.

We’re not making any moves today but we will be keeping an eye on these stocks and see how they react to end of the year positioning.