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Traders’ Protocol Before Cisco Q1 Earnings: Get Bearish

Demand concerns could pop up in revenues


Networking giant Cisco Systems (NASDAQ:CSCO) is slated to slip into the earnings confessional after the close of trading this afternoon, and doubts appear to be creeping into analysts’ heads.

For the record, Wall Street is looking for a fiscal first-quarter profit of 41 cents per share, a figure that is up a penny over the past month and up 7.9% from the same quarter last year.

The analyst community’s revenue outlook, however, is on shaky ground. Despite expectations for a 4.8% year-over-year rise to $11.26 billion, there are concerns that a marked slowdown in demand during the past two months could weigh on Cisco’s quarterly sales. In an article on Barron’s, Stifel Nicolaus analyst Sanjiv Wadhwani said, “This is a reversal from the trend in the July quarter, where the company saw positive order trends in the second half of the quarter, especially in the U.S. market.”

The brokerage community also is concerned about Cisco’s second-quarter and full-year guidance, with many analysts expecting the technology bellwether to remain cautious because of the “fiscal cliff,” which would hit Jan. 1, 2013, if Congress is unable to reach a budget agreement.

“We presume that US businesses — not sure of how the Fiscal Cliff will impact them — may be getting more cautious on investment right now,” Jefferies & Co. told investors in a research note.

But if pessimism is on the rise, it is not being seriously reflected in Cisco’s sentiment indicators. For instance, reveals that the company’s first-quarter whisper number arrives a penny higher than expectations at 47 cents per share. Additionally, 25 of the 46 analysts following CSCO rate the shares a buy or better, compared to just 3 sell ratings.

In other words, there is plenty of room for post-earnings maneuvering (i.e., ratings downgrades or price-target cuts) if Cisco confirms the brokerage community’s fears.

Turning to options activity, speculative traders are leaning heavily toward the bullish end of the spectrum. Options activity was brisk on Cisco yesterday, as roughly 67,000 calls and 66,000 puts changed hands on CSCO. The most popular strikes were the Nov. 17 and Dec. 19 calls, which each saw volume of more than 9,900 contracts. On the put side, the Nov. 16 and Dec. 15 strikes were most active, with 6,400 and 8,100 contracts trading, respectively.

CSCO should continue to see heavy options activity today, as traders position themselves ahead of tonight’s report. Those looking to join the fray should know that November implieds are pricing in a post-earnings move of about 6.6%. Given the abundance of optimism surrounding Cisco’s quarterly report, and the very real potential for a misfire on either revenue or guidance, traders might want to consider a bear put spread.

Since only the most advanced options traders should consider trading front-month options ahead of a questionable earnings report, let’s take a look at the December 16/17 bear put spread.

At the close of trading on Monday, this trade was last offered at 43 cents, or $43 per pair of contracts, placing breakeven at $16.57 — a decline of about 1.7% from yesterday’s close.

A maximum profit of 57 cents, or $57 per pair of contracts, is possible if CSCO closes at or below $16 when December options expire.

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

Article printed from InvestorPlace Media,

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