Cybersecurity play Fortinet (FTNT) is set to release its earnings after Wednesday’s closing bell. And if history is any indicator (and if option traders have it right), FTNT should be securing additional year-to-date gains for bullish investors.
In front of Wednesday’s after-hours release from Fortinet, Wall Street is expecting the company to turn a profit of 2 cents per share of FTNT for its second quarter. The forecast profit is down 60% year-over-year from 5 cents, but up sequentially from the first quarter’s penny take on for its bottom-line and one that beat estimates calling for the company to breakeven.
Last quarter, shares of FTNT surged by nearly 10% after the company topped Street views punctuated by “record billings growth and solid large-enterprise deal growth,” according to Barron’s.
The report also saw an eighth consecutive sales beat and year-over-year growth of 26%, prompting broker Piper Jaffray to raise its price target in FTNT from $38 to $45 while maintaining its “overweight” rating.
However, earnings beat consistency in Fortinet has been lacking. In the prior three quarters, Fortinet managed to miss profit estimates by 12.5%, 40% and 16.67%. But with FTNT in a growth hotspot — and one that’s just coming of age — bottom-line misses haven’t entirely stopped investors.
FTNT stock’s post-earnings movement for the past six quarters has resulted in an average move of 3.25%. If we look at the percent magnitude of each reaction by stripping out the directional bias, we find the average close-to-close change in FTNT shares is 5.57%, with a one standard deviation of wiggle room of 3.29%. That said, there’s also a longer-term bias of FTNT reacting to the upside 80% of the time.
FTNT Daily Trading Chart
Click to Enlarge
The most recent analyst action was a cut to “underperform” — essentially, “sell,” — from “market perform” from Cowen & Co.
Cowen maintained its $37 price target on shares of FTNT while noting that expectations have become too lofty, and that investors risk being disappointed after an advantageous 2014, tougher comps and difficulty breaking into the highly competitive enterprise market.
Technically, after breaking out from a significant four-plus year base at the end of 2014, we estimate the bulls are in control of FTNT stock. In our view, Fortinet is forming a bullish first-stage weekly base following a count reset in late January, which importantly successfully tested the former highs, then proceeded to rally to fresh all-time-highs of $44.12 by mid-June.
FTNT Options
In Monday’s session, volume in the option pits was moderate, with the most active market spied in the Sep $40 call. Roughly 900 contracts compared to open interest of about 2,200 with a closing mid-market price of $3.65 with shares of FTNT at $42.43.
With implied prices rising and continuing to spread above underlying price volatility in shares of FTNT, premiums are near the highs around 40% set during the prior two earnings events. In this instance, though, the difference between the two types of volatility is greater and a crush in premiums is even more likely.
A drop in implieds on the heels of the report fails to account for the earnings move itself. Based on implied pricing of around 37% in the August at-the-money contracts, we can determine traders are pricing in a 68% chance FTNT remains between $37.75 and $47.25 through expiration which is 33 calendar days out.
Option traders in FTNT are preparing for a volatile event, but certainly not over the top as implieds are still modestly below recent reports. Still, there are two trading days left for premiums to adjust further.
It should be noted that beyond FTNT, other cybersecurity stocks are set to report over the next week. Check Point Software (CHKP) reports first on Wednesday morning, Vasco Data Security (VDSI) is next Tuesday afternoon and FireEye (FEYE) announces its results that Thursday after the close.
FTNT Bullish Strategy
Given premiums are expected to shrink following Fortinet’s earnings report — and despite (or maybe because of) the history of an 80% upside record in FTNT stock and believing trends do sometimes end suddenly — I like the Aug $43/$45 bull call spread for 80 cents or better ahead of earnings.
For 80 cents or less, the trader’s expiration breakeven of $43.80 in FTNT is well inside the upper boundary of our estimated expected range boundary of $47.25. And if shares are above $45 in 33 calendar days, the position will return $1.20, or 150%.
In the event historical trends in FTNT stock do not make an appearance and it turns out Fortinet’s most recent and less optimistic broker calls are correct, there is less than 2% stock risk involved with this vertical spread. At the end of the day, the limited risk feature could save traders from unwanted bearish intruders and keep potential losses nice and small.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual.
