Salesforce (CRM) For the Birds

by riskreversal October 5, 2016 1:02 pm • Trade Ideas

On September 8th we took a look at Salesforce (CRM) and determined that there was a strong possibility that the stock would remain under pressure into their Q3 report in November. The main reason being the weakness in billings was unlikely to be a one quarter issue and that the guidance was probably still too optimistic. But the other, almost equally important reason was the report they might have bid close to $30 billion for LinkedIn (LNKD) if given a chance after Microsoft’s $26.2 billion bid, and recently their interest in a bid for Twitter (TWTR) that could be $20 billion. Today, CRM shares are down 6.5% on a story from the WSJ that bids for TWTR could come as early as this week and that CRM is very likely to be involved:

Twitter Inc. is expected to field bids this week, and Marc Benioff has been building a case to Inc. investors and others that his company should be the buyer, according to people familiar with the matter.

To be fair we did not think that the second part of our thesis would have such a dramatic impact on the stock near term, despite thinking it is a clear headwind. But the issue for our trade idea was that it was targeting news in November, not early October. Here was the trade idea from Sept 8th:

CRM ($74.50) Buy Nov 75 / 65 / 55 put butterfly for 2.25
  • Buy to open 1 Nov 75 put for 3.75
  • Sell to open 2 Nov 65 puts at 85 cents each or 1.70 total
  • Buy to open 1 Nov 55 puts for 20 cents each

With the stock 67.75 this put butterfly is worth about 3.80 mark to market vs the 2.25 original cost. That beats a sharp stick in the eye but the stock would have to settle in around here in order for it to be worth what it could be intrinsically. At 67.75 it’s intrinsically worth 7.25 vs the current 3.80 mark to market. So that’s a lot of decay yet to be collected. It’s max value of course on Nov expiration is at 65 where it would be worth $10.

The other thing working against potential profits here is that implied vol in CRM has spiked on the news:

[caption id="attachment_66867" align="aligncenter" width="611"]screen-shot-2016-10-05-at-10-20-30-am 6 month IV30 (red) vs HV30 (blue) from LiveVol[/caption]

The reason implied vol hurts the butterfly is it’s adding premium to the 65 short puts, as there’s now more uncertainty for where the stock will be going forward. So when a move happens early in a profitable butterfly there are choices to be made. Is that profit worth it at this point at nearly a double? Or is taking profits here just leaving too much on the table.

The way I would look at it is that since it’s still in the middle of a news cycle that could change dramatically in the next few days you have to figure out the risk of CRM having a snap back higher above the break-even level of where the profits are now. That level with a current mark to market of 3.80 is 71.20. That’s a little bit higher than where the stock closed yesterday, so it can be assumed if news hits that CRM is not in the running for TWTR you’d likely see the stock back to that break-even level more or less.

So the main thing to be weighed here on this trade is whether the current profits are worth that risk, or if you’re simply happy with the profits on this surprisingly early move.

Lastly, taking a look at the chart since the start of 2015, $65 seems to be a decent target, now its just a matter if it goes there and stays put.  This is a great example of having the facts right but kind of whiffing on trade structure 🙁

[caption id="attachment_66874" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]