Making a Bearish Bet on BMC Software

by John Kmiecik | August 13, 2012 8:23 am

The market has had quite a good run higher the last couple of weeks or so. Some pretty decent economic reports have spurred this rally, but a dark cloud is still hanging over the global economy. The trade suggestion listed below has a lot of similarities with the market as of late. BMC Software (NASDAQ:BMC[1]) missed estimates on a couple key factors that analysts look for, but the stock has still managed to rally higher.

Here’s a trade idea that might be able to take advantage of that dark cloud.

BMC Software ($41.25): Long Puts

The trade: Buy the September 41 puts for $1.30 or less.

The strategy: The long put is implemented when a trader has a bearish outlook on a stock. The trade can profit if the stock falls, and the put premium increases as the option moves farther and farther in-the-money (ITM) and is worth more than was paid. Maximum profit is almost unlimited because the stock can only fall to $0 (which is highly unlikely), and the maximum loss is $1.30 if BMC finishes at or above $41 at September expiration. Breakeven is $39.70 at expiration based on a cost of $1.30.

The rationale: BMC develops software that provides system and service management solutions for companies in the U.S. and internationally. BMC reported earnings on Aug 1, and they were exactly good. The company missed estimates on revenues and earnings per share, and the stock tumbled lower.

Since the earnings decline, BMC has been on a tear higher, so why the bearish outlook? The stock has rallied right to a resistance point just below $42 on an extended move up. For this trade idea to work, resistance needs to keep this stock from heading higher, and buyers will need to agree that it’s currently overbought.

What might be also advantageous is volume has been declining over the last week, which might indicate the buying is drying up.

As of this writing, John Kmiecik had no position in any security mentioned here.

Endnotes:
  1. BMC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BMC

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