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This morning, I am recommending a bearish trade on Cisco Systems, Inc. (NASDAQ:CSCO).
As I said last week, we are in a corrective phase. The market looked like it was going to handle the tariff increase well, but after China announced retaliatory tariffs yesterday, the markets fell even more.
Of course, the current correction could easily reverse itself and the market could head higher again if a deal is made, but I think that’s pretty unlikely in the near term. At a White House event last night, President Trump said it could be three to four weeks before we know whether or not the trade talks are successful.
In the meantime, all sectors of the U.S. market are vulnerable, and I’m looking for cheap downside protection where I can find it. CSCO was headed lower yesterday, and I think tech stocks in particular are a good place to look for bearish plays.
CSCO reports earnings tomorrow, after the close. The stock was trading lower yesterday, and it’s difficult to say whether that’s due to negative sentiment surrounding the upcoming report. It’s entirely possible that investors are cautious because, like many other tech companies, CSCO has a lot of exposure to China.
Despite the fact that China’s retaliatory tariffs will primarily affect the farming sector, the escalation is a bad sign. If the U.S. expands tariffs on China again, it could have a greater impact on CSCO.
Breaking Below Key Support
If we turn to CSCO’s daily chart, we see it has been trending lower since setting a new all-time high in mid-April. The escalation of tariffs last Monday may have accelerated the stock’s decline. CSCO broke below support at $52 yesterday, and if it heads below the $50.50 level, it could retest support at just above $46.
Daily Chart of Cisco Systems, Inc. (CSCO) — Chart Source: TradingView
A strong earnings report from CSCO could help bolster the stock against the current trade issues, but that would only be temporary.
It’s important to remember that earnings are a report of past performance, and if investors see trouble on the horizon, even after a positive report, they may look to lock in their profits, sending CSCO lower. For that reason, I’m recommending a bearish ratio put debit spread on CSCO.
Using a spread order, buy to open 1 CSCO June 21st $48 put and sell to open 2 CSCO June 21st $45 puts for a net debit of about $0.12.
Note: There are several June expirations available for CSCO options. Be sure you are opening the monthly options that expire on Friday, June 21, 2019.
About Ratio Put Debit Spreads
A ratio debit spread is simply a way to lower the cost of buying options, as the two option(s) that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this ratio put debit spread is a way to lower the cost of establishing a bearish put option trade. Many brokers will require the use of margin and/or a set amount of reserved capital and/or a margin account to execute a debit spread; contact your broker directly for specific requirements.
Because you are short a naked put in this ratio put debit spread, the risk is that you could be obligated to buy 100 shares of CSCO at the $45 strike price for every 1 contract that you are short of the CSCO June 21st $45 puts. So, this is inherently a higher risk play.
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Ken Trester is editor of the popular Maximum Options program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.