As we have repeated stated, trading a market that moves more by political headlines rather than by economic fundamentals becomes increasingly tricky. That’s why conservative investors may want to stay on the sidelines.
Aggressive investors, however, may want to take advantage of market corrections to pursue bullish options spreads on stocks that have beaten earnings expectations and are on the rebound. Cisco Systems (CSCO) is one of them. The company beat Wall Street expectations, once again, as it reported an EPS of 43 cents on $11.26 billion revenues, compared to an analyst expectation of an EPS of 39 cents on $11.03 billion revenues.
Here is a simple strategy that pursued for my own portfolio today that can yield 22 percent in two months with low risk:
I sold five contracts of a January 17.5 put at 77 cents, collecting $385.
I bought five contracts of a January 15 put at 21 cents, paying $105.
This means that I did collect a net premium of $280 or roughly 23% gain if Cisco stock that closed at $18 stays above $17.50. My downside risk is to lose this money if the stock closes below $15.
I do believe this is very unlikely even in the current shaky market, as Cisco is beginning to turn the corner in a few areas:
1. The top line. Cisco’s top line was up 5% to $11.26 billion, exceeding analyst expectations - not bad for a mature $82 billion gorilla with 5.5 billion shares (the company reduced its outstanding shares by 100 million last quarter through buybacks) and tens of thousands of employees. The law of large numbers is, therefore, working against Cisco - though it didn’t work against Apple (AAPL).
What was encouraging, however, was that revenue from new products increased by 7% - suggesting that Chambers' “One Cisco” strategy works. The bottom line should include “a number of unusual items," such as the recently announced layoffs.
2. Innovation. Cisco seems to be shifting from an external to an internal innovation model that is more sustainable. But Chambers didn’t give any details about this shift as there weren’t any questions on this issue.
3. Guidance. The company gave an upbeat guidance (a 7% increase on the top line and a 3% increase on the bottom line) that exceeded analysts' estimates. Mr. Chambers was bullish on the company's prospects in Japan, and though he used the words “in times of limited spending," and "difficult macroeconomic environment," he avoided the use of words “challenging environment," uncertainty: and "unclear visibility."
Disclosure: I am long CSCO. I also own a bullish spread, as described in the article. As an active investor, I may change positions at anytime.