There have been a number of calls during the past few days to sell Alcatel-Lucent (ALU), largely based on the fact that the stock has gained over 200% over the past year and it will likely fall over the next two months. I believe the short-thesis on the stock is wrong, and there are more reasons to be positive for Alcatel-Lucent than negative. Let's look at some of these reasons.
Sell Now? I Don't Think So.
Let's tackle the sell ALU now thesis - first of all, the proponents of selling the stock are mainly concerned about the short-term progress of the stock; no one doubts the long-term prospects of the company. So, the advice is actually for the frequent traders - investors who are always looking to outsmart the market and make a few bucks here and there. The advocates of selling the stock believe that the investors will be able to pick up shares at lower prices; what if the stock price does not come down, what if it goes further up? If that happens, long-term investors will surely suffer. My advice to long-term investors: Do not sell. However, if you believe the stock will likely fall in the short-term and have bullish view in the long-term, taking a position in options might be an attractive choice.
The rally made by ALU during the past year was not speculation, it was because the management came with a strong plan and up till now, the plan has shown a considerable further movement. The main concern according to the advocates of selling the stock is that the company will report losses in the upcoming earnings announcement. No one is expecting the company to report profits, as the management has set a target to return to profitability in 2015. The target right now is to report lower losses than in the previous quarters, which I believe the company will do due to the decrease in costs and growth in the top line. In my opinion, the company will report narrower loss, further positive update on "The Shift Plan" (I believe the target for the current year has been achieved), and the stock will likely move higher.
However, let's assume for a moment that the short thesis is correct and being a long-term investor, you fear that the stock price may fall over the next two months. A better strategy to benefit from the fall will be to sell put options rather than selling the stock. Selling the put option means the investor has a bullish view in the long-term - the seller of put options makes the commitment to buy the stock if it falls below a certain level. Selling the put options will allow you to collect premium, which will result in profit if the stock price does not fall and the options are not exercised. However, if the stock price in fact falls and the options are exercised, it will give you an opportunity to grab some shares at a lower price.
ALU's current open interest in options market gives a clear indicator where the market is expecting the stock to go; let's take one strike price for a reference. Open interest for March 22, 2014 calls with strike price of $4.33 is at 15,602, and the open interest for put options is 1,427 - the open interest for put options is less than 10% (9.14% to be specific) of the open interest of call options. Let's suppose an investor expects the price to fall in the short-term; selling a March 22, 2014 put option will give the writer $0.50 per share in premium. If the stock falls below $4.33, the option may be exercised - in case the option is exercised, the writer will have to buy the shares. However, the premium collected at the time of writing the put option will bring the cost basis down to $3.83 per share. So, the writer will only face a loss if the stock is trading below $3.83 per share at the time of the exercise of the put option. I personally believe this strategy can be far more profitable for those people who are bullish about the stock in the long-term than selling the stock in hope of buying it later at lower prices. However, options are extremely risky, and if you do not have deep knowledge and understanding, then you should probably stay away from options.
An update on Vectoring Technology
Vectoring technology is getting a lot of love from the operators. ALU has secured six customers for its VDSL vectoring equipment. I talked about the most recent addition in my last article. Other networking equipment providers are also getting on the vectoring technology train. Huawei recently provided equipment to Eircom to deploy on its fiber network. There is a lot of infrastructure available, and the operators will want to save on costs of building new fiber infrastructure. A survey conducted by Broadbandtrends in May last year indicates that 70% of the operators interviewed were either in trial or deploying the technology. There is a clear opportunity in this segment and the company looks to be making good moves.
As I have long maintained, I believe Alcatel-Lucent is on the right path, and the stock will continue to grow as the company continues to show improvement. When we are analyzing ALU, we should take into account that the company is making a recovery, and it should be analyzed step-by-step. No one can predict the future with certainty, but I do believe that Alcatel-Lucent's stock will continue to outperform in 2014. However, if you fear a small pullback and want to benefit from the fall by picking up some stocks at a discount, then the above mentioned strategy might be helpful. However, I cannot stress it enough that options are extremely risky and it should not be pursued if you do not understand options.