Cisco Systems (CSCO) will report their fiscal Q2 results tonight after the close. The options market is implying about a 5% one day move tomorrow in either direction (or about $2), which is just a tad rich to the four-quarter average of about 4.7% but a little shy of the ten-year average one-day post-earnings move of about 5.6%.
In the recent broad market downdraft shares of CSCO had a 13% peak to trough decline, which was slightly higher than that of the Nasdaq Composite’s 11.5% decline, but since the lows on Friday, CSCO has recovered at a greater speed than the broad market, now down just 1.75% from its prior highs, vs the Nasdaq down about 5%. Optimism about tonight’s earnings and outlook might be the culprit as investors expect positive commentary about the impact of the recent corporate tax cuts and the potential for greater capital return on their almost $40 billion in net cash.
Aside from the company’s strong balance sheet and cheap valuation, analysts expect good news in core businesses, per Barron’s: “networking switch sales to cloud data centers to show continued momentum”, while other checks “indicate CSCO has secured recent awards or expanded footprint at, among other customers, GOOG, MSFT, Alibaba and Baidu”.
With the stock up 10% on the year, trading just below 17-year highs, the question is whether or not near-term good news is in the stock?
While short-dated options prices are down considerably from the recent multi-year highs, they remain very elevated, still well above the pre-earnings levels of the last few years at 30%:
The stock’s strong rebound and the high levels of implied vol make long premium directional trades challenging into earnings, as you could get the direction right, but the magnitude of the move could determine profitability.
If the implied one day move tomorrow is a little less than $2, then that means with the stock at $42, to pick a direction and define your risk only costs you $1. Let’s say I was inclined to be long into the print and thought the stock could move in line with the implied move, which would place the stock above the prior high of $43 on January 29th then I might look to buy call spreads. For instance, the Feb 16th 42 – 45 call spread is offered at 50 cents (stock ref $42, buying 1 Feb 42 call for 95 cents, selling 1 Feb 45 call at 15 cents). The max risk of the trade is 90 cents, or about 2%, with gains of up to $2.20 between $42.80 and $45, with a max potential payout of $2.20 if the stock were $45 or higher.
For those who are looking down in the stock after the print, the Feb 42 / 39 put spread is offered at about 80 cents with same risk-reward profile. risk 2% to make 5%
Whether you are bullish or bearish, these trade ideas offer an attractive defined risk way to play, but I’ll offer our normal disclaimer for long premium directional trades into events, you need to get a lot of things right to merely make money, the direction of the stock, magnitude of the move and timing.
The key to this strategy no matter what your view is conviction on a directional move and the inclination to define ones risk.