Event: Cisco Systems (CSCO) reports their fiscal Q3 results tonight after the close. The options market is implying about a 5.5% one day move tomorrow, which is a tad rich the 4 qtr average one day move of about 5%. I would add that in the last 5 quarters the stock has had 2 one day post earnings rallies of about 9.5%.
Price Action / Technicals: Shares of CSCO are down about 1.5% on the year, and down about 11% from its 52 week highs made in May of 2015.
Since making 8 year highs in early 2015, CSCO has been in a noticeable downtrend making a series of lower highs and lower lows:[caption id="attachment_63754" align="aligncenter" width="600"] CSCO 5 year chart from Bloomberg[/caption]
If you see the trend channel that I see, there appears to be risk to the low $20s on a miss and guide down.
Taking a view from the 2000 highs, the stock was just rejected at what would have been a massive long term breakout level:[caption id="attachment_63755" align="aligncenter" width="600"] CSCO 16 year chart from Bloomberg[/caption]
My Take Into the Print: CSCO is a cheap stock trading 11.6x expected fiscal 2016 eps growth of 4% on flat sales growth. And from a balance sheet and capital return standpoint, it is considered defensive, with 45% of their market cap in cash, 26% net of debt. It also pays a dividend that yields nearly 4% and in the company is in midst of a $15 billion share repurchase program.
Potential hiccups for guidance is likely the company’s reliance on emerging markets for future growth and their more than 50% revenue exposure outside the U.S. In the quarter just ended, the U.S. Dollar weakness might have a minimal impact, as the DXY (US Dollar Index) is down less than 2% from the time they last guided to at the end of April, and the rebound in May from 52 week lows might restrain forward guidance as the recent blip of better than expected data has expectations of rate hikes increasing a bit, which would likely cause a rip in the U.S. dollar back towards 52 week highs, and thus a tailwind for CSCO’s overseas sales and profits.
I suspect asymmetrical risks are to the downside post results so I think hedges and stock alternatives are in order to define risk.
So What’s the Trade?
For those looking to be long or stay long CSCO, defining risk in case there’s a surprise to the downside makes sense:
In lieu of 100 shares of CSCO (26.90) buy the July 26/29 call spread for 1.25
- Buy 1 July 26 call for 1.43
- Sell 1 July 29 call at .18
Rationale – This trade has a breakeven at 27.25 which is .35 higher than where the stock is but it limits possible losses to the downside to 1.25, which is about the implied move. So where this trade works great in lieu of stock is on a big downward move where this can be sold at a loss and stock re-bought. It’s unlikely to lose more than half its value on a move lower since it’s looking out a few months. On the upside it will act like stock, albeit with less deltas so not immediately realized. If the stock is above 29 profits are capped. For those worried about that scenario the 26 call by itself may make sense but do know that vol will come in after earnings so a flat or small move and this will have losses. This strategy is best for those that are ‘bullish but worried’.
There’s also a leverage trade we wanted to point out for those that are long. The May (expiring Friday) upside calls set up for some potential 1×2 plays. For instance:
Against 100 shares of CSCO (26.90) buy the May 28/28.5 call 1×2 for .01
- Buy 1 May 28 call for .21
- Sell 2 May 28.5 calls at .10 (.20 total)
Rationale – This 1×2 leverages shares above 28 to 28.5. (The implied move to the upside is about 28.15). If the stock is at or above 28.5 this strategy adds up to .49 in additional profits. You are called away in your shares but at an effective price of 28.99. These strikes can be adjusted to fit your comfort level. If 28.99 isn’t your bag, the 28.5/29 1×2 is also 1c and offers up to .49 in leverage and an effective call away price of 29.49. (near the highs) This trade does not hedge in any way, it’s simply for those looking to add yield in case of a move higher.