Fundamentally, it’s hard to compare NetApp Inc. (NASDAQ:NTAP) and its competition, but I can say that it’s not cheap from a price-to-earnings perspective. Gross margins are decent, but the P&L eats the profits up to the bone before it reaches the net level. So profitability is less than ideal.
Luckily expectations are humble. Most analysts rate it a hold, so if there were to be a rating-change headline it’s likely to be an upgrade surprise not a downgrade.
Furthermore, NetApp offers a dividend with about a 1.9% yield. This is important because equity markets are at all-time highs, so we are open to dips. Stocks that offer dividends usually hold up better in market-wide corrections than those who don’t.
Technically, the 12-month daily chart shows recent stability, which usually indicates consolidation ahead of another move higher.
Click to Enlarge But when I zoom out to a weekly chart I see big downside potential. So any bullish setup needs to make room for error especially that earnings are coming tonight.
If I buy the stock at $40 now, my money is at risk immediately and with no buffer. So I will use the options instead, where I can structure risk that allows a margin of error appropriate to the potential technical risks.
The thesis today is that NTAP stock will hold above $35 per share for the next few months … and if it doesn’t, I am ready to buy it at a discount.
NTAP Stock Trade Idea
The Bet: Sell the Aug $34 NTAP put for $1 per contract. With this, I have an 80% theoretical certainty that I will retain maximum gains. Otherwise, I will own the stock and accrue losses below $33 per share. Since management will report tonight, I would sacrifice a few pennies buying protection for the next two weeks just in case.
I usually like to balance my trades by selling opposing risk but in this case I will delay this step for at least a week to see how this side performs.
Selling naked puts is a daunting task for many. For those people, I can turn this bet into a bull put spread instead.
The Alternate: Sell the Aug NTAP $35/$34 credit put spread. With this, I have a slightly smaller theoretical chance of success but with more limited risk. The cost of the compromise is not severe since I can still yield 14% on risk. Compare this with risking $40 per share then hope that the stock rallies 14% just to match the performance of the spread.
Selling options is risk business, so I only risk what I can afford to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.