Anatomy of a Trade – $CRM & $PANW Stock Alternatives

by CC February 26, 2016 3:19 pm • Trade Ideas

Buying the dip in a market like this comes with some high risk but also the potential for high reward, especially in single stock names. We highlighted two such names the past few days Recently beaten up cult stocks Salesforce (CRM) and Palo Alto Networks (PANW). Both stocks were set to report earnings and we discussed long stock alternatives that looked to define risk in case of a meltdown but tried to mimic long stock to a realistic upside, in both case targeting their 50 day moving averages and the implied moves. So let’s check in on the trade ideas. First, CRM from Wednesday:  

In Lieu of 100 shares of CRM ($61.90) Buy the March 60/70/80 call fly for 3.10
  • Buy 1 March 60 call for 4.50
  • Sell 1 March 70 calls at .75 (1.50 total)
  • Buy 1 March 80 call for .10

Rationale – This defines risk to 3.10 (the most that can be lost if the stock declines below $60) while allowing for profits up to 6.90 (maximum gain of 6.90 at $70) So this is a better position than stock in almost all cases as you know what you can lose, but can also target a fairly realistic upside. The risks of this trade are the stock going sideways to down slightly (to $60) where it will act worse than stock, but not by much as it starts nearly 2 dollars in the money, so it’s only really about a dollar in extra premium vs the stock (break-even of 63.10)

And PANW from yesterday:

In lieu of 100 shares of PANW ($128.50) Buy the March  125 / 150 / 175  Call butterfly for $7.50

  • Buy to open 1 March 125 call for 10.90
  • Sell to open 2 March 150 calls at 1.80 each (3.60 total)
  • Buy to open 1 March 175 call for 0.20

Break-Even on March Expiration:

Profits: above 132.50 and below 167.50 with max gain of 17.50 at $150

Losses: of up to 7.50 below 132.50 and above 167.50 with max loss below 125 and above 175

Rationale: Similar to the CRM trade from yesterday this defines risk in case of a steep decline on the event while targeting a realistic upside in the stock over the next few weeks. The trade is no longer bullish at 167.50 but the odss of that kind of move are small, so 150 seems realistic. The fly starts in the money by 3.50 so only $4 of the trade is extrinsic premium (i.e. the trade’s breakeven is $4 higher than where stock is now).

These trades were intentionally very similar. Both were in the money call flies and both targeted a move back to 50 day moving averages on the upside. And that’s exactly what happened. Here’s CRMs 3 month chart with the 50 day in red (70.12):

[caption id="attachment_61761" align="aligncenter" width="632"]Screen Shot 2016-02-26 at 12.55.28 PM CRM from LiveVol Pro[/caption]

And here’s a 3 month in PANW with the 50 day in red ($154):

[caption id="attachment_61762" align="aligncenter" width="634"]Screen Shot 2016-02-26 at 12.58.52 PM PANW from LiveVol Pro[/caption]

So what to do now with these? The positive aspect of doing an in the money fly into an earnings event is you’re able to define your risk in case you’re wrong. The negative aspect to an in the money fly into the event is unless expiration is the next day all your gains aren’t fully realized and you either need to take what you got, or be patient for the balance of the premium to decay and your in the money calls to go 100 delta, realizing the full value of getting the move right.

Checking in on the CRM, the stock failed to get above the 50 day average but is still hovering close to that level. And that level is the maximum value potential if the stock goes sideways from here until March expiration. The trade is nearly a double from the 3.10 paid, but intrinsically it has a lot more potential. So if I was in this trade I’d be patient and perhaps take profits if the stock started to move away from the strike. So maybe 67 and 73 are my mental stops on either side of the the 70 strike. A move there in either direction and it’s probably not worth rooting for it to return to the 70 strike. On the flip-side, if the stock were to bang around in a 2 dollar range around 70 I’d wait on it. The theta (decay) of the position is about 8 cents today. That means more than 15c over the weekend. And that accelerates over time. And that’s all in your favor.

Now moving on to PANW it’s a slightly different situation because the stock seemed to get rejected a bit at that 50 day moving average. With the stock now $145 this trade is worth about $13 vs the 7.50 initially paid. So very similar to CRM in that it’s almost a double, and just below the max gain sweet spot. But perhaps this one needs to be on a tighter leash because it did get as low as 141.45 this morning and has a really wild ride on the results yesterday, at one point as low as 122.70.

So with a mark to market value of 13 and intrinsic value of about 15 this one is more on the edge if it does move lower. I’d keep the lows of this morning as the mental stop on this one and try to be patient otherwise. Ideally that shook out some profit takers and the stock can move higher to 150 over the next week or so. But if it did violate this morning’s lows I’d take the money and run. This has potential to be worth close to $20 if it can close on expiration near 150, and with theta (decay) about .16 a day in your favor (you collect). So it’s worth being patient, but also disciplined and not greedy. Use mental stops.