Cloud computing, or the provision of computational resources on demand via a network, has been a strong emerging trend in the information technology industry. The core concepts underlying the technology have spawned a new era in web development and have also enabled other rapidly growing industries – like software-as-a-service (SaaS) and virtualization – to scale at a whole new level.
As a key enabler to such rapidly growing markets, cloud computing companies have seen rapid growth over the past few years. By 2012, the Software-as-a-Service market is projected to grow at a 20% CAGR to $21 billion; the Platform-as-a-Service market is projected to grow at a 160% CAGR to $9 billion; and the Infrastructure-as-a-Service market is projected to grow at a 60% CAGR to $4 billion.
The Stocks and the Strategies
The key public companies operating in the cloud computing space are Amazon.com Inc. (NASDAQ:AMZN), F5 Networks Inc. (NASDAQ:FFIV), EMC Corporation (EMC) and Juniper Networks Inc. (NYSE:JNPR). Meanwhile, companies implementing cloud computing across various industries include VMware Inc. (NYSE:VMW), Salesforce.com Inc. (NYSE:CRM), and Riverbed Technology Inc. (NASDAQ:RVBD), among others.
Investors looking for broad exposure in the sector may want to consider purchasing a basket of cloud computing stocks, but hedging them against a broad index to reduce some of the market risk. For example, investors could purchase a basket of these stocks and then purchase a protective put on the SPDR S&P 500 ETF (NYSEARCA:SPY) for the same dollar amount.
A Sample Hedged Cloud Trade
Investors may choose to purchase 50 shares of FFIV for $5,100, 180 shares of EMC for $4,900, and 130 shares of JNPR for $4,900 for a total stock position valued at $14,900. Then, the investor could purchase an SPY at-the-money 135 Jan. 12 protective put for $7.30 per contract. The result would be a $15,630 investment in a basket of cloud computing stocks with downside protection from the protective put.
As a way to further mitigate risk, investors could write short-term out-of-the-money covered call options against their basket of stocks. This strategy would result in a lower capital investment and therefore less risk and higher returns over the holding period. The only risk is that the stock is sold prematurely at a higher price than the investor paid for it (plus any commissions).
In the end, many analysts agree that the information technology industry is seeing a secular move from traditional to cloud computing. The rapid growth in many cloud computing end markets – ranging from server virtualization companies to software-as-a-service providers – means that the underlying providers of the technology should also see significant growth over the coming years.
Using this options strategy, investors can benefit from the growth in cloud computing without worrying about major corrections in the overall market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.