The stock market has been in turmoil from back and forth global tariff war headlines mainly between the U.S. and China. Just this week we saw a whipsaw action as the U.S. dialed up the rhetoric another notch.
This morning the stock market is bouncing from yesterday’s dip. But not Broadcom (NASDAQ:AVGO) stock.
AVGO management announced today that it is acquiring CA, Inc. (NASDAQ:CA) for $19 billion in cash and debt which is a 20% premium.
Wall Street is reacting negatively to the headline. AVGO is down 17% on the news.
This dip is severe, but therein lies the opportunity. Often when investors panic sell a quality company, it creates opportunities for those brave enough to catch the falling knife. No, I will not risk $200 per share to buy the Broadcom stock outright without leaving any room for error. Instead, I use options where I can create a buffer zone between current price and my level of risk.
Fundamentally Broadcom is not cheap from an absolute price-to-earnings ratio perspective. But it’s priced in line with the sector as they typically command higher valuations. So there is value and eventually Wall street we’ll figure it out.
But meanwhile there is technical risk. AVGO stock is now testing a two-year-old pivot point. Those often provide support on the way down. But a candle this size is not likely to be a one day event so more downside could still be coming. While this is not a forecast, it is a scenario for which I need to be ready.
There’s also upside potential in the long run. Management says that the deal will improve EBITDA margins so more investors will eventually see better value in the stock. Shorter-term upside potential could also come from the deal falling apart due to shareholder or antitrust objections to the it.
Two Potential AVGO Trades
If my thesis is incorrect and AVGO continues falling precipitously, then the worst-case scenario is that I own the stock at a deeper discount than even now.
This is a scenario that I accept because I am confident that I could manage out of the position for a profit in the long run. This is a rinse-and-repeat trade for me so I come to it with profits in hand.
The Trade: Sell AVGO OCT $155 naked put and collect $1.75 to open. Here I have a 85% theoretical chance that I would retain maximum gains. But if price falls below my strike then I accrue losses below $153.25.
Those who want to mitigate the risk that comes with selling naked puts can sell spreads instead.
The Alternate Trade: Sell AVGO OCT $160/$155 credit put spread. The spread has the same odds but would deliver 11% yield on risk. Neither trade require a rally to profit. In fact the stock can fall an additional 24% and I could still retain maximum gains.
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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.
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