These bullish trades could pay off big when optimism returns
Tech is dead, right? With many leading tech stocks hitting 52-week lows and the debate raging on over whether a double-dip recession is on the way, it’s hard to get enthusiastic about the sector. But if this pessimism turns out to be overblown, it could lead to big returns for option traders.Tech may not be as dead as reports have indicated. A number of companies have solid balance sheets and technology valuations are lower than many investors have ever seen.It’s true that companies are giving mixed guidance, and that in the past, such slowing has been the start of a major contraction cycle. But what if things are different in this no-to-low-growth environment? Even with limited guidance and visibility, some of the tech leaders may continue to meet or beat earning expectations and show revenue growth. What’s more, M&A activity has picked up and the midterm elections should remove some of the uncertainty plaguing the market.So I’ve put together a list of five option trades that should prove tech is far from dead.
Brocade Communications Systems, Inc. (NASDAQ: BRCD) recently hit a 52-week low, but the stock has held up fairly well considering its place in the tech world behind Juniper Networks, Inc. (NYSE: JNPR) and not even on the map compared to Cisco Systems, Inc. (NASDAQ: CSCO).The most recent earnings report was sloppy due to a tax benefit and light revenues, and guidance was also light for its fiscal fourth quarter. But Brocade could easily become a buyout candidate now that Cisco has decided to go after the data center market. And Dell Inc. (NASDAQ: DELL), International Business Machines Corp. (NYSE: IBM), Hewlett-Packard Company (NYSE: HPQ), Huawei, and others could all come knocking, as well. Shares were roughly at $8 on an adjusted basis before it merged with Foundry Networks in 2008. They are now around $4.80 after reaching as high of $9 and change in late 2009. I’m looking at the BRCD Jan 2012 7.50 Calls at 28 cents. Even if the stock continues to falter in the short term, the 17 months of time value will keep this erosion from being extreme.
MEMC Electronic Materials, Inc. (NYSE: WFR) is often considered a stock with an identity crisis as it makes wafers and related products for both the semiconductor and solar energy sectors. Both industries are having issues, and WFR has seen a boom and bust to the point that shares are down nearly 90% from all-time highs during the solar energy bubble. When its latest earnings came out, the company discussed some obvious margin compression as you are seeing in chip and solar reports. It also said it expects to exceed its earlier 2010 revenue guidance of $1.75 billion to $1.85 billion, but expects earnings below its previous guidance of 70 cents to 80 cents. What the company does have going for it is that its guidance and its price-to-book value and price-to-tangible-book value offer a value proposition. At $10.27, the stock’s 52-week range is $9.19 to $19.31. Value alone won’t keep the stock from sliding some more, so we’re not looking at a short-term play. Buy the WFR Jan 2011 12.50 Calls for roughly 50 cents. The goal here is not so much to see the strike price hit as it is to gain upside exposure, and on a deleveraged basi,s this offers less downside than if you bought the shares and put in a stop-loss order at the 52-week low.
Anyone doing value screens for a low P/E and revenue multiple will come up with Western Digital Corp. (NYSE: WDC). Its P/E ratio comes up at 4, which is about 6 times the $3.91 EPS target for fiscal 2011, which ends in June.The problem WDC faces is that the internal and external storage sector is extremely competitive when it comes to price, and the company competes head-to-head against Seagate Technology (NASDAQ: STX). The cost of a terabyte of storage is now approaching $100, an unthinkable price per byte if you remember how much it cost when the Internet was just taking off. This has led to margin compression. But Western Digital is one of the beneficiaries of Apple Inc.’s (NASDAQ: AAPL) growth, as its external storage devices are prominent over other brands in Apple stores. Filling up a terabyte is not easy to do, but the rate of storage is rapidly on the rise even among individuals. If the market and consumer stabilizes going into the holiday season, and Apple sales continue to grow, it could mean big things for WDC.Currently around $24, its 52-week trading range is $23.52 to $47.44, and shares were at $30 as recently as July 20. The WDC Jan 2011 29 Calls can be purchased for less than $1 per contract. If the stock rises just 10% on a market pop after August, these options would likely bring about a solid return.
Since the Mark Hurd debacle, Hewlett-Packard Company (NYSE: HPQ) has been putting in 52-week lows just about every day, and the stock closed Wednesday at $38.24. It seems the sex scandal couldn’t have come at a worse time. Cisco Systems, Inc. (NASDAQ: CSCO) is entering the data center market, so HPQ’s former customer is now a competitor. And things would have been much easier for the company if Hurd was there to help oversee the 3Com and Palm integration, and to deal with a potential bidding war for 3PAR Inc. (NYSE: PAR). But the acquisitions have helped the company move away from PCs, servers and printers, and it is now a full IT conglomerate. The big question is whether HPQ can meet its earnings guidance and, therefore, keep its low earnings multiples. With the fiscal year-end in October, HPQs implied forward P/E ratios are 8.5 for 2010 and 7.7 for 2011. We will be the first to point out that low P/E ratios do not mean much for growth in technology, but since the Hurd fiasco, shares have been hit by more than 17%. If the stock can rectify itself soon, the HPQ Nov 43 Calls for about 75 cents offer a lot of leverage with more than 85 days to go before expiration.
Microsoft Corporation (NASDAQ: MSFT) has done nothing for longer than anyone cares to remember, for the most part remaining stuck between $20 and $30 for years. Slowing PC demand is no secret. Perhaps the move to smartphones, netbooks and tablets is hurting traditional laptop and PC sales more than expected, but an all-out replacement isn’t going to happen. And even with Apple Inc. (NASDAQ: AAPL) gaining market share, Macs can run Windows, Word and Office, which MSFT is compensated for. Additionally, in July, it was reported that Windows 7 was outselling expectations.With fiscal estimates at $2.36 EPS for June 2011 and $2.64 EPS for June 2012, the current share price of about $24 generates a forward P/E ratio of 10.1 times current year and 9.1 times 2012 estimates. While cheap does not always translate to good in technology, how low does the earnings multiple have to go? And what if you back out that $40 billion-plus cash and securities from its $208 billion market cap? Plus, the company still has a one-time dividend or a share buyback to consider, which could come before year-end. So it might be worth looking at the MSFT Jan 2011 27.50 Calls for around 55 cents. The premium erosion of these options based on time value should not start to accelerate until October or November.————-Double Your Money on the Rumor AND the News — Learn how to cut through the rumor and manipulation surrounding corporate earnings announcements and bank money-doubling option trades all year long. Download our FREE trading guide here.
