Earlier, Dan previewed Cisco’s Q4 results due after the close. As Dan mentioned, the options are implying about a 1.25 move in either direction. That helps inform potential trade structures dependent on your prior or desired positioning. Let’s dig in…
Vol is higher into the event but not ridiculously so. Therefore there’s not a ton that sticks out on the board that makes sense for straight up directional plays. But like a lot of stocks this earnings cycle, it is near recent highs and therefore defining risk makes sense for further upside, versus the potential for a failure here. Especially given the news of layoffs Dan mentioned.
Despite being down today, CSCO is within .75 of its multi-year highs. For those looking to position for a breakout, but with the idea of defining risk and call calendar vertical makes sense where a call expiring Friday but outside the implied move, which can then finance a closer to the money strike call out in October:
CSCO (30.50) Buy the August 32/ October 31 vertical call calendar for .60
- Sell 1 Aug 32 call at .15
- Buy 1 Oct 31 call for .75
Rationale – The implied move to the upside for the event would put the stock at about 31.75. If the stock were to move higher in that range, as long as the stock is at or below $32 on Friday’s expiration the Aug 32 call will expire worthless, leaving a financed October 31 call that can then be close for a profit or roll the expiring short call out and up, creating a vertical in October to participate in more upside on a breakout. There’s a chance (not a big one) the stock greatly outperforms the move higher and is substantially higher than the short 32 Aug strike. If that’s the case the trade is still profitable but could max out out at .40 in profit. Which would be disappointing in that it wouldn’t participate in a bug gap higher but better than a sharp stick in the eye because it’s still profitable. If the stock were to go lower, the most that can be lost is the .60 paid. But since that premium paid is out in October the likelihood of losing all of that .60 is virtually impossible. It would take a very sharp move lower. If the stock were to go nowhere (a decent probability) this could be a slight loser as the .15 sold in August may not be enough to cover losses in the vol collapse in October. But Oct vol isn’t pumped that high, so any losses would be minimal and you’d still be positioned well for subsequent moves higher. So the best way to think about this trade for those that want to bullishly position is that it has a nice profile if the stock goes higher, a decent profile of the stock goes nowhere and a defined risk if the stock goes lower where it’s unlikely the entire .60 is lost if the direction is wrong.
Now let’s look a some options for those that are already long CSCO in their portfolio. There’s an opportunity to add leverage to the long stock position by doing an upside 1×2 call spread:
Leverage on a long:
Against 100 shares of CSCO (30.50) Buy the Sept 32/33 1×2 call spread for .05
- Buy 1 Sept 32 call for .35
- Sell 2 Sept 33 calls at .15
Rationale – This 1×2 call spread acts as leverage for any moves above the implied earnings move, but with an expiration that captures the aftermath in case the stock continues higher over the next month and change. Since it only costs .05 that’s the most that can be lost if the stock is below 32 on Sept expiration. But above that, it has the opportunity to add up to .95 in yield/leverage. If the stock is 33 on September expiration it will have added .95. If it is above 32 it no longer adds leverage and is basically being called away in the stock but at an effective sale price of 32.95 or 8% higher in just 5 weeks time.
For those that simply want to hedge an existing position there’s not anything great to sell upside to finance a put, so simply buying an at the money put like the August 30.50 put for around .50 is probably the cheapest way to do that, protecting against any move below $30 on the event. But that’s about 1.5% of the underlying and could be worthless on Friday if the stock is above 30.50. So that’s only for those particularly worried about their long.