Broadcom Ltd (NASDAQ:AVGO) reported earnings last night and Wall Street loved what they saw. AVGO stock is trading up 4% on the headline. Coming into the event, the stock was already up 45% year-to-date, so the rally continues.
The report was decent as management beat expectations on the top- and bottom-lines. They also guided forward without any alarming asterisks, so investors breathed a sigh of relief. Regardless, it is likely that markets were not too worried about the execution, but rather the headlines from their bid for Qualcomm, Inc. (NASDAQ:QCOM).
Personally, I think that from a price action perspective, the looming headline is a win-win situation. I believe that the near-term traders will buy AVGO stock if they succeed or fail in their QCOM acquisition efforts.
Headlines aside, fundamentally AVGO stock is far from cheap. But we are in the age where we need to invent new terminology, like “the cloud” and “internet of things,” to refer to the many new ways that we depend on tech.
We need it now more than ever and we will increase our dependency on it even faster going forward. Broadcom being a provider of a broad variety of tech — pun intended — has room to prosper with or without QCOM.
Central to my bullish bet today is that I see value in AVGO stock’s price-to-book ratio. At 5.5, I am confident that it won’t be a massive mistake if I have to own the shares at a discount. In this strong macroeconomic environment, traders will buy the dips to support my trade.
Today’s rally off the earnings headline means that I have to leave plenty of room for error just in case AVGO faces profit taking in the new year. In 2017, investors consolidated AVGO well between $240- and $260-per-share. This usually creates a support zone because it becomes a demarcation area where both bulls and bears want to win, so they fight hard for it.
Today, I will set my bullish bet below said zone for the best chance of success, then let time do the rest.
The Bet: Sell the AVGO Jan 2018 $230 put for $2. Here I have a 90% theoretical chance of success. Otherwise, and if the price falls below it, I would suffer losses below $228.
Selling naked puts carries big risk, especially for a stock that is prone to headlines like AVGO. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the AVGO Jan 2018 $240/$230 bull put spread, which has about the same odds of winning and would yield 15% on risk. Compare this with risking $264-per-share and without any room for error except a rally profit.
Ultimately, 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.