Slipped Disk – $STX

by Dan July 7, 2016 1:07 pm • Commentary• Trade Ideas

Western Digital (WDC), the hard disk drive maker who recently completed their acquisition of flash storage provider Sandisk, reported sales and earnings last night that beat prior guidance, including Sandisk results.  Shares of WDC are up 5%, while shares of hdd competitor Seagate (STX) are up 2% in sympathy.  Given the fact that both stocks are down materially on the year (21% & 35% respectively), and down about 50% from their 52 week highs, today’s bounce isn’t that impressive in my opinion. Especially when you consider STX’s short interest is nearly 11% of the float.  Last week STX announced a restructuring where they laid out a cost cutting plan that included firing 1600 workers, or 3% of their workforce, in an effort to put an end to a fairly epic multi-year eps decline from $6.75 a share in fiscal 2013, to the expected $1.73 a share in the fiscal year just ended in June.

The main concern at this point is figuring out how to maintain their current $2.52 a share dividend that sports a current annual yield of 10.5%.  I’ll remind readers that STX was forced to discontinue their dividend at the height of the financial crisis in 2009 when the company swung to an earnings loss and did not reinstate one for 2 years:

[caption id="attachment_64842" align="aligncenter" width="600"]from Bloomberg from Bloomberg[/caption]

From a long term technical perspective, it could be said that STX is at an inflection point, just above $20 support, a level that once breaking in 2008 saw its shares drop 85% before its bottom in 2009, but failed to meaningfully break above until early 2012.  Also the stock is now just above the long term uptrend from the 2009 and 2011 lows:

[caption id="attachment_64843" align="aligncenter" width="600"]STX 10 yr chart from Bloomberg STX 10 yr chart from Bloomberg[/caption]

So What’s the Trade?

If you are inclined to play for a breakdown, on an earnings miss / guide down that would lead investors to fear for a dividend cut when the company reports the last week of July (not confirmed yet), then it makes sense to finance long August puts by selling shorter dated ones that do not catch the earnings event:

At this point I am interested to see if WDC/STX have any follow through, but this is the trade structure I might use to play for a breakdown:

STX ($23.90) Buy the July 22nd weekly / August regular 23 put calendar for $1
  • Sell 1 July 22nd weekly 23 put at .60
  • Buy 1 August 23 put for 1.60

Rationale – Ideally STX pulls back in the next few weeks leading up to earnings. At or near $23 on July 22nd the short put can be rolled into August regular, creating a cheap put spread vertical that captures earnings. If the stock goes higher or sideways in the meantime the short put will help with decay as the August put should stay bid.