The Cisco Systems, Inc. (NASDAQ:CSCO) stock slide that started in May persists. It is now 11% lower, which counts as an official correction. Fast-moving tech stocks become threatening falling knives … but I’m willing to add to longs as long as Wall Street runs for cover.
Fundamentally, not much has changed for CSCO. From a price-earnings ratio perspective, it is half as cheap as Microsoft Corporation (NASDAQ:MSFT) and runs better net margins. So there isn’t much froth in the stock.
There are risks, however. First, comes from the fragility of the equity markets in general. The second is technical. Below $30.50, Cisco stock becomes vulnerable to momentum selling. There are a couple of technical setups that might entice investors to press the short. If that happens, then it could fall into the clutches of a long-term consolidation zone and therein lies the opportunity.
Long-term pivot points usually make for fierce battle zones between bulls and bears. Neither side is likely to let them go without a fight. This often translates into a stalemate, and in this case, support. I am, however, willing to own the CSCO shares if it falls to such levels.
Click to Enlarge Before you label me a permabull, consider this CSCO bearish trade that delivered profits out of thin air. When I shorted the stock in March I felt that the rally was too frothy. It came too far, too fast.
I wasn’t dissing the company’s long-term outlook. In fact, I leveraged the good fundamentals to finance my bearish trade.
Today, I will not buy the Cisco stock and hope it rallies. Equity markets in general are still too close to all-time highs, so the risk of a correction is still elevated. Instead, I will sell risk below support levels to generate income.
The trick here is to find value areas where the bulls will step in and buy it if price continues to slide. I only do this with quality stocks that have a long-term ongoing story. I don’t do this with speculative stocks whose outlook is uncertain.
The Bet: Sell the CSCO Jan 2018 $26 put and collect 65 cents to open the risk. Here I have an 85% chance that I will retain all my premium for maximum gains. But if price falls below my strike I have to own the shares and then could suffer losses below $25.35. It is important that I be able and willing to own the shares should that happen.
For those who do not want to commit to this ownership I can sell a spread instead. There the risk is limited to the width of the spread less what I collect to open.
The Alternate Bet: Sell the CSCO $26/$25 credit put spread where I stand about the same theoretical chance of success. Even though this has limited risk it still delivers a juicy 15% in yield.
In either of these trades, all I need is for CSCO stock to stay above my strikes. This gives me a 15% buffer from current price, so price can continue falling and I still can win. Compare this with buying the stock at face value and without any room for error hope it rallies.
Investing is risky business otherwise it would have no reward. It is important that I never risk more than I am willing 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.