Why I'm Still Bullish On SanDisk

Apr.28.12 | About: Western Digital (WDC)

In a previous article related to SanDisk (SNDK) posted on April 2, 2012, a bullish position for SanDisk was considered. However, the bullish position was in the form of a married put, so the position was protected from a large drop in stock price. Following the article, SanDisk reported poor results and a poor outlook and as a result SanDisk's stock price took a hit as shown below:

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SanDisk's stock price is currently down about 24% following the previous article, but the married put position is down a much less 8.7%. In the article, the maximum downside was noted as 7.2%, which should have been explained as a maximum loss at expiration, so if we continued to hold the married put position to October expiration, the maximum loss would be 7.2%. However, exiting the position today would result in a loss of 8.7%.

In SanDisk's Q1 2012 earnings call held on April, 20, 2012, Sanjay Mehrotra, President and CEO of SanDisk, indicated the company's poor results were a result of an imbalance between supply and demand, which is expected to continue into the next quarter and then alleviate in the second half of the year with the ramp-up of new smartphones, tablets, ultrabooks and enterprise solid state drives. Additionally, the second half of the year should improve due to seasonality. SanDisk also noted that due to the supply/demand imbalance, the company is pushing the start of Fab 5 out into 2013.

SanDisk's problems appear to be temporary and the company appears to have a roadmap for recovering from the supply/demand imbalance hiccup. So a bullish outlook for the company is still warranted.

The nice thing about the married put strategy, as illustrated by SanDisk, is an 8.7% loss is much easier to recover than a 24% loss. At this point, a number of options are available with respect to the married put position, including holding the married put position, using income generating methods as described by RadioActiveTrading.com or closing the position and substituting it with a different position.

In general, it's not a good idea to take capital from one losing stock and put it into an entirely different stock, as often the investor gets "bit twice by two different dogs". However, if the stock is in falling knife mode, then getting back into the same stock is not wise. But, SanDisk is a good company that has run into some choppy water, so consideration will be given for replacing the current SanDisk position with a significantly more risky SanDisk bull-put credit, yet with SanDisk's stock price in the cellar, a position with a good chance for success.

A bull-put credit spread may be entered by selling one put option and purchasing a second put option further out-of-the-money. The goal is to have both options expire worthless and keep the initial credit as profit. An attempt to recover from the 8.7% loss will be executed with multiple trades instead of trying to recover the full 8.7% loss all at once.

Looking at SanDisk's stock chart above, the company's stock price has found support in the $32 to $34 range three times in the last two years, so a short put option strike price for the bull-put credit spread in the $32 to $34 range should be sufficient.

Using PowerOptions Mid-Point Spread Chain tool, some available bull-put credit spreads for SanDisk are shown below:

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The 2012 May 31/34 bull-put credit spread has a potential return of 4.2% (69.7% annualized) and the strike price of the short put option is 9.7% out-of-the-money. The specific put option to sell is the 2012 May 34 at $0.17 and the put option to purchase is the 2012 May 31 at $0.05. The net credit received for this position is $0.12 ($0.17-$0.05). A profit/loss graph for one contract of the bull-put credit spread is shown below:

A management point of $35.5 is set for the bull-put credit spread. For a stock price below the $35.5 management point, the position should be managed for a roll or exit.

With this initial bull-put credit spread, about half of the previously sustained loss can potentially be recovered, with the remaining loss to potentially be recovered by other positions which will be entered at a later date.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.