Our regular readers know we’ve been holding a long stock position in Cisco Systems (NASDAQ:CSCO) since early August. Our CSCO August 2nd $56 put write expired in the money, and we accepted the shares when they were put to us. We’ve been selling covered calls on the stock ever since.
The last time we sold a covered call on CSCO, we were still waiting on the company to report earnings. Now it has, and we think it’s a good time to sell another covered call. We can collect income while the stock continues to consolidate.
CSCO’s Earnings Have Kept it Down
At its last earnings report in November, CSCO beat both earnings and revenue expectations — coming in at $0.84 earnings per share and $13.16 billion in revenue. That was good news for the company, but unfortunately, its guidance for 2020 wasn’t as strong as investors might have liked.
For the second fiscal quarter of 2020, CSCO expects revenues to decline between 3%-5% on a year-over-year basis. The company expects earnings per share from $0.75-$0.77, which would represent a small increase since the second fiscal quarter of 2019.
Unfortunately, it is a demanding market, and CSCO’s mixed guidance will likely keep it within its $44.50-$46 trading range in the near future. While that means our stock won’t gain value as quickly as we hoped, it also gives us an opportunity to collect extra income using a covered call.
Collecting While we Wait
After management guided earnings expectations for the current quarter lower, CSCO dropped to support at around $44.50. Interestingly, this support level has held up quite well. The stock tested it nearly every day for a week, but it hasn’t broken.
Daily Chart of Cisco Systems (CSCO) — Chart Source: TradingView
On the other side, resistance at $46 has been just as firm. This price level served as support in late August and again through most of October. It marked the bottom of the gap CSCO formed on Nov. 14.
We’ve been waiting for one of these levels to break, but traders just don’t seem interested in pushing CSCO one direction or the other right now.
That lack of movement is precisely what we want to take advantage of with this covered call. By setting a strike price above resistance at $46, we can limit our chances of having our stock called away. There isn’t a lot of premium in these options right now — a consequence of CSCO’s relative stability — but any additional income will help us while we wait for CSCO to head higher.
We chose the $48 strike price because it is in line with the top of the gap CSCO formed on Nov. 14. If the stock breaks up through resistance at $46, we expect most of this gap to get filled, and having a $48 strike price will decrease our odds of having our shares of CSCO called away from us.
As with most covered calls, traders should avoid obligating themselves for too long. We eventually want CSCO to head higher. When it does, we can become more aggressive with our strike prices. If traders commit too much time to this trade, they may give CSCO too much time to recover, and they won’t be able to roll this covered call out for a profit when the time comes.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of Strategic Trader.