Back in late May I made the case why NetApp (NTAP) could find itself in the sights of potential acquirers (here):
investors are already speculating who can be on HPE’s shopping list. NTAP has long been rumored to be a take-over candidate from large enterprise hardware vendors like CSCO, HPQ & IBM, and since last year’s fairly complicated deal announcement of DELL buying EMC/VMW the rationale only makes more sense. There is on big problem for NTAP though, their sales have been declining over the last few years, this year expected to be $1 billion or about 16% below their 2013 peak, with earnings down about 23% from their 2014 peak. But the stock is cheap, trading 11x expected fiscal 2017 eps, and only 1.4x sales, and ,7x enterprise value to revenue. Yep, NTAP has a ton of cash on their balance sheet, about $5 billion, or about 57% of their $7.4 billion market cap, or 47% net of their $1.5 billion in debt.
NTAP is headquartered in Sunnyvale, California, and has about 13,000 employees, and they are about 10 miles down the road from HPE. I suspect the Queen of Cost Cutting, M&A and Spin-offs (Meg Whitman) would love to get her hands on an asset like this. Or maybe relatively new CSCO CEO Chuck Robbins would like to get the party started with a $10 billion acquisition.
Shares of NTAP are up about 25% from its post Brexit lows, trading this week at new 2016 highs. There are plenty of reasons for this performance, balance sheet, cash return, valuation and m&a environment. But heading into tonight’s fiscal Q1 results, the stock could be poised to give back some of the recent gains on a weak quarter and guidance.
The options market is implying about a 6% one day move following tonight’s results, which is rich to stock’s 4 qtr average one day move of only 2%. The high implied move may set up nice for traders with a directional inclination who may have the opportunity to sell short dated options to help finance longer dated ones. (more on that later).
Near term though a bull back to the nearly converging 50 and 200 day moving averages could be in the cards:
[caption id="attachment_65737" align="aligncenter" width="600"]
NTAP 1yr chart from Bloomberg[/caption]
So Whats the Trade?
How do you target a pullback to the converging moving averages while defining risk? One way is to start in the money and reduce extrinsic premium at risk with a butterfly. We’re not doing this trade ourselves but it stuck out to us as the best way to play for a pullback over the next 4 weeks:
NTAP (28.75) Buy the Sept 29/26/23 put butterfly for .75
- Buy 1 Sept 29 put for 1.14
- Sell 2 Sept 26 puts at .22 (.44 total)
- Buy 1 Sept 23 put for .05
Breakeven on Sept expiration – Losses of up to .75 above $28.25 with total loss of .75 above $29. Losses of up to .75 below $23.75 with total loss of .75 below $23.
Gains of up to 2.25 below 28.25 and above 23.75 with max gain of 2.25 at 26 on Sept expiration.
Rationale – this defines a profitable range in the stock of 23.75 up to 28.25 or a 4.50 wide range. It starts in the money (.75 paid vs starting .25 in the money) which means it’s not all premium at risk. The gains of a move lower aren’t instantly realized and one would have t be patient in order to collect all the intrinsic value of a move lower, but vol will come in… so as long as the stock is below its breakeven of 28.25 that works in the trade’s favor. If the stock goes nowhere or higher it also won’t lose all of its value. The most that can be lost if the stock does gap higher is the .75 paid, which is much less than the implied move. So this trade is a defined risk way of playing for a pullback to the converging moving averages with a decent payout of 2.25 to .75 risked. And that .75 risked is less than half of the implied earnings event move.