Trading Palo Alto Networks Inc (NYSE:PANW) around its earnings report is not for the faint of heart. This stock has moved 20% or more twice this year on earnings week. Those short-term reactions so far have each reversed other. So the knee-jerk reactions have not been long term game changers, although they do cause grief to those in the stock at the time.
This week I want to go long PANW stock into earnings, but considering how much it moves, I will use options. There I can build a sizable buffer to guard my risk. Otherwise I would need to risk $140 per share to buy the shares and hope traders will not beat the stock down.
Timing of entry points do matter especially in a momentum stock like this.
Fundamentally and like most momentum stocks, PANW is not cheap. But it’s not alone as this is symptomatic for the industry.
We all know how important e-security is and the most recent Equifax Inc (NYSE:EFX) debacle most likely rekindled the fears. So the Palo Alto Networks stock should benefit into our digital future. We are accelerating our dependency on technology at an exponential rate. Most companies in this sector should thrive.
PANW stock’s price-to-book is almost 18 which makes it a tough valuation to swallow. So it’s crucial that my buffer be large enough so I can successfully manage my risk in case we see adverse reactions to earnings.
So in the absence of value, I am left betting on the price action itself.
Technically, PANW has been setting higher lows since April. Bulls have been hammering on a neckline around $148 per share. If they can prevail in breaching the zone then they could overshoot higher towards $162.
Given the binary nature of earnings events, my trade will not depend on this outcome to profit. I will leave a big enough buffer so I can still retail maximum gains even if PANW falls another 15% from here. But it is important to note that I am willing to own the shares lower should the worst case scenario happens to my set up.
Click to Enlarge Opinions are still high for PANW stock on Wall Street. There are too many analysts with a strong buy rating. This could present a problem if the company disappoints. It could create a deluge of negative headlines. Although this is not a forecast, I have to recognize the potential.
The average price target on the street is still about 12% higher than current so in theory better things are to come. The high mark is $196 per share. The most pessimistic target is $108 so there is no easy consensus. Clearly the experts are in a holding pattern close to mid range.
So I rely on the fact that PANW stock found support around $112 per share and I will use that as a reference to where I am willing to place my risk
PANW Stock Trade Idea
The Trade: Sell the PANW Jan $120 put and collect $2 to open. This is a bullish trade which has an 85% theoretical chance of success. If price falls below $118 my strike I will accrue losses.
Selling naked puts carries big risk especially in a somewhat frothy stock. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the Jan PANW $120/$115 bull put spread where the risk is much smaller. Yet, if the spread wins, it delivers 15% in yield.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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 as @racernic on twitter and stocktwits.