Rolling Cognizant Technology Solutions

Jun. 1.12 | About: Cognizant Technology (CTSH)

In a couple of previous articles related to Cognizant Technology Solutions (NASDAQ:CTSH) posted on April 19, 2012 and May 11, 2012, a protected covered call was considered for the company in the first article, and following a drop in stock price, the protected covered call was replaced in the second article with a bull-put credit spread. The bull-put credit spread was entered in an attempt to recover the -7.6% loss sustained for the protected covered call. The -7.6% loss for the protected covered call is much easier to recover than the -16% loss sustained for a long position in Cognizant's stock.

A protected covered call may be entered by selling a call option against a stock and using some of the proceeds from selling the call option to purchase a put option for protection. The protected covered call provides a position with the potential to generate a return even if the price of the stock remains stagnant, yet also provides protection in case the stock price takes a hit.

A bull-put credit spread may be entered for a credit by selling one put option and purchasing a second put option further out-of-the-money. The goal is for the options to expire worthless at expiration and to keep the initial net credit as profit.

In the most recent article, a management point of $57.50 was set for the bull-put credit spread. If the price of the stock drops below $57.50, consideration for managing the position for an exit or a roll should be given. The price of Cognizant's stock has breached the $57.50 management point (shown below), so we'll investigate the alternatives for a roll or an exit.

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To exit the current position requires a net debit of $0.70 as found by PowerOptions' tools and shown below:

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The initial bull-put credit spread position was entered for a net credit of $0.46, so closing at a net debit of $0.70 will realize a loss of -$0.24 which represents a loss of about -5%, so exiting does not look like a great choice at this point.

Since exiting does not look attractive, we'll investigate rolling down and out-in-time. Looking at July, the 2012 Jul 47.5/52.5 bull-put credit spread can be entered for a net credit of $0.88 as found by PowerOptions' tools and as shown below:

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It is possible to roll the 2012 Jun 50/55 bull-put credit spread to the 2012 Jul 47.5/52.5 bull-put credit for a net credit of $0.18 ($0.88-$0.70), which represents and additional potential return of about 3.6% and a total potential return for both bull-put credit spreads of 13.7%. The 13.7% return also represents a net return of 6.1% over the -7.6% loss sustained for the protected covered call.

A management point for the new bull-put credit spread position is set for $54.50. If the price of the stock drops below $54.50, the new position should be managed for an exit or a roll.

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