Ride the Fence With This Cisco Stock Trade

by Joseph Hargett | May 13, 2014 10:42 am

Cisco Systems (CSCO[1]) is scheduled to release its fiscal third-quarter earnings report after the close of trading Wednesday, and the short-term outlook for Cisco stock hangs in the balance.

For opportunistic traders, an options trade on Cisco stock ahead of the report might be just the ticket.

Cisco Earnings Expectations & Sentiment

CSCO is expected to post a profit of 48 cents per share, with revenue seen falling 7% year-over-year to $11.38 billion. Historically, Cisco has topped estimates by an average of 1 to 2 cents per share during the past four reporting periods, leading to a whisper number of 49 cents per share from EarningsWhisper.com.

Cisco is in the midst of a couple overreaching factors that could influence Wednesday’s quarterly report:

• First, there is a major upgrade cycle taking place in the data center and telecom markets, as companies move to replace their aging 1G switches for faster 10G and 100G backbones. Demand has been especially brisk across Europe and parts of Asia.
• On the other hand, Cisco’s business services units are battling a move toward cloud services and away from traditional enterprise software. Cisco is attempting to transition alongside these market developments, but the costs of keeping up with more nimble startups is eating into Cisco’s bottom line – hence the year-over-year declines in revenue.

As a result, Cisco stock has attracted a mixed following among Wall Street analysts and investors. Specifically, CSCO shares have attracted 23 “buys,” 15 “holds” and four “sells,” according to data from Thomson/First Call. Additionally, the 12-month price-target for CSCO of $25 rests a mere 7.8% above the stock’s Monday close.

On the options front, calls are the investment vehicle of choice. For instance, the May/June put/call open interest ratio for CSCO rests at a bullish 0.41. Peak call strikes include the weekly May 23 call, with 100,296 contracts, and the weekly May 25 call with some 51,800 contracts.

Click to Enlarge Overall, Weekly May 16 option implieds are pricing in a potential post-earnings move of about 4.5% for Cisco stock, but this initial move could set the shares’ course for the next several weeks. CSCO stock has been bouncing around the $20 region for the better part of the past four years, with highs near $26 and lows near $15 — both levels are well outside the $22-$24 range suggested by May 16 options implieds.

The shares are currently trading just north of the midpoint of this range, leaving plenty of downside potential in the event of an earnings miss or lackluster guidance. That said, any positive notes could spark a round of upgrades from those stagnant brokerage firms with “hold” ratings.

Options Trade on Cisco Stock

The easiest way to solve this conundrum is to either wait for confirmation of the trend following Cisco’s earnings report on Wednesday, or to enter a straddle options trade ahead of the event.

A straddle involves simultaneously buying an at-the-money call and an at-the-money put in an attempt to take advantage of a greater than expected move from the underlying stock.

In CSCO’s case, implied volatility appears to be a bit low heading into Wednesday’s report, meaning that option implieds may be underestimating the potential post-earnings move. With a positive earnings report potentially sending Cisco stock back toward its highs near $26, and a miss potentially seeing the stock test support at $20 or below, a June $23 straddle might be a good way to take advantage of this situation.

At last check, the CSCO June $23 straddle was offered at $1.32, or $132 per pair of contracts. Breakeven for this trade lies at $24.32 on the upside, and at $21.68 on the downside.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2014/05/csco-cisco-stock-earnings/

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