Adobe Systems Incorporated (NASDAQ:ADBE) reported earnings last night and investors are selling the stock on the headline. Management beat bottom-line expectations, but only met revenue expectations, albeit at record levels. I like that the recurring revenues continue to grow. This provides a consistent stream of revenues upon which they can continue to plan for bigger and better things.
Today’s Wall Street wants to see the wow-factor and usually that comes from forward guidance. ADBE management only guided inline revenues so that perhaps contributed to the reaction of disappointment. This is a relative term these days made worse because we just had new all time highs in the NASDAQ, where we see massive moves on frothy momentum tickers.
So odds are that this dip is exaggerated by the money flow out of something that is sound and solid like ADBE to chase the frothy tickers. Luckily, I have recent profits from being long momos like Tesla Inc (NASDAQ:TSLA) and Netflix, Inc. (NASDAQ:NFLX), so I will roll some of the risk into a fundamental bet into ADBE’s 2018 prospects.
Add to it a sprinkle of ADBE operating imperfections with regards to margin and you get yourself a run-of-the-mill dip after a long run. Is the rally over? Hardly! To that, the ADBE CFO said that they expect their momentum to continue. Usually CFOs are not overtly confident so this is a testament that the upward trend shall continue through 2018.
Today’s dip is painful to those newer longs, but ADBE is a stock that came into the report up 85% in a year and 45% in 2018 alone. So a small retracement is necessary to maintain the overall trend.
Dips in Adobe stock are rare and shallow. So they don’t appear like obvious long entry opportunities. That is why I use options to generate my profits without needing upside momentum. Today I sell downside risk against what others fear today. I am confident that proven support in the stock will hold, especially that management still has a large buyback program to help my cause.
ADBE stock is not cheap since it sells at a price-to-earnings ratio of 64. This is three times that of Apple Inc. (NASDAQ:AAPL) and twice that of Facebook, Inc. (NASDAQ:FB). And this is another reason why using options makes more sense then buying the shares outright with no room for error. In options, I can dig a large moat around my risk in case the selling persists.
I don’t need a rally to profit. If proven support holds through 2018, then I retain my maximum potential profit. Otherwise, I own ADBE shares but at a deep discount from current price.
Technically, ADBE has several pivot levels that should provide support on the way down. The first is at $240-per-share, then the next three are $10 apart from that. Each of these should be reliable, but not bullet-proof given the slant of the wedge. If they break, they can overshoot on the way down. So I will hide my risk behind all of them.
The Trade: Sell the ADBE OCT $200 put for $2.50. Here I have an 85% theoretical chance of success. Otherwise and if price falls below it, then I would suffer losses below $197.50.
Those who want to mitigate the risk that comes with selling naked puts can sell spreads instead.
The Alternate Trade: Sell the ADBE OCT $200/$205 bull put spread, which has about the same odds of winning and would yield 15% on risk. Compare this with risking $250-per-share here and without any room for error and expecting a rally profit.
Click here for more of my market thesis and get an ongoing free copy of my weekly newsletters.
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.