One look at the Palo Alto Networks Inc (NYSE:PANW) chart and you’d agree that it’s a momentum stock. Earnings reactions tend to be violent. Case in point, back in March the stock fell over 20% in just one day. And even after today’s spike, the bulls have yet to recover from that March cliff.
Momentum stocks like PANW pose a problem to traditional investors. When they rally, they go fast — so fast that they scare most traders out waiting for a pullback. Conversely, when they fall, they appear headed into an abyss — again keeping traders out for obvious reasons.
That’s why I only use options to trade the likes of Palo Alto Networks stock. So far this year I’ve had a perfect record with four home runs. All with no out-of-pocket expense.
Today I am looking for a repeat performance. The only difference is that this time I am chasing a rally, whereas usually I catch it as a falling knife.
Fundamentally, although there is no actual value to measure, the company is in the e-security and threat business. And since our globe is definitely going to be completely dependent on tech, the need for their services will only increase. So there is little doubt that PANW has the opportunity to flourish as long management avoids massive gaffes.
Technically there are a lot of clues. Coming into earnings, PANW stock was stuck in a long term pivot zone.
Click to Enlarge Back in February of 2015, PANW stock broke through resistance and has since defended it several times. Admittedly they’ve gone below it a few times, but supports are rarely hard lines.
The upwards reaction on earnings makes this yet another bounce from this long-term level of contention, and therein lies my value proposition. This is something that I can leverage in order to create income out of thin air one more time this year.
Even though the stock has already shed a lot of fluff, I do worry about unreasonable expectations. Most analysts still have it as a buy, but more importantly, their price targets are all above current levels. If price takes its time to reach their levels, this could compel them to reprice the ranges. This is code for downgrade headlines from so called experts.
Current price is just barely touching the bottom end of the PT range so I need to build a buffer for safety.
PANW Stock Trade Idea
The Trade: Sell the Dec $110 PANW put and collect $2 to open. Here I have a 90% theoretical chance of success. But if the stock drops below my put then I would accrue losses under $108 per share.
Selling naked puts requires margin. Those who want to mitigate this downside exposure can sell spreads instead. There, the risk is limited by the width of the spread.
The Alternate Trade: Sell PANW Dec $110/$105 credit put spread, which is also bullish but with much less at stake yet yields 15%.
I won’t hedge this setup by selling opposite risk to balance. I am counting on my support levels to hold through expiration.
Investing is risky, so I am cautious to never bet more than what I am able to lose.
Learn how to generate income from options 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 @racernic on Twitter and Stocktwits.
