I wrote an article on Cisco (CSCO) in March and it was centered on a debit spread trade with the company. At that time it kept rising. I was sure there would be a turnaround sometime during the year, though I did not know when. So on this trade I bought way out into October waiting for a turn down. As I wrote in the article, analysts believing the stock would not rise further, and unimpressive revenue growth were the main factors in this bearish play.
Here was the trade I originally wrote about:
The Option Trade
Buy an October 2012 '20' put option (priced at $1.42)
Sell an October 2012 '19' put option (priced at $1.02)
Net Debit to Start: $0.40
Maximum Profit: $0.60
Reasoning behind the Trade
The stock is at the top of the Bollinger Bands and tends to move to the bottom of the band.
This is within our trade range.
Analysts do not believe the stock will move up much more.
Unimpressive revenue growth could put a damper on further growth.
It's very close to its expected 52 week high.
October gives us room for the stock to move a bit more if it anted up to before it pulls back.
We all know where Cisco is today. Using hindsight, it appears the unimpressive revenue growth was the beginning of a much greater macro-economic slump that would hit Cisco and other companies very hard. The stock rose enough that I thought at some point it would turn down. I just did not know it would happen so quickly.
Today Cisco was trading at $17.095 and, reversing this trade, here is how it came out:
Sell the October 2012 put with a strike of '20' (priced at $3.20)
Bought the October 2012 put with a strike of '19' (priced at $2.42)
Gross Profit: $0.78
Net Profit: [gross profit - original net debit]($0.78 - $0.40)= $0.38
Where do we go from here with Cisco?
I wrote at the beginning of May that I believe Cisco is a good long-term investment now. The market has reacted to the poor track record and has priced itself in.
Thinking about the future of the company, I like what Investment Underground wrote in an article June 8th when he talked about how the company is positioned for the future. He writes:
Cisco has tremendous market positions in various categories around the world. During the first quarter of 2012, it held an 85% worldwide market share of the access routing network and a 70% share of the LAN switching market. It has substantial "cloud" technology, and will have a worldwide role in the build out of cell phone 4G LTE networks.
So I believe the company is set for the long-term (I'm praying this global problem eases eventually). But at the same time, if I was going to put money in the stock, at this point I would put it on a watch list and do my due diligence, eying a possible time when I believe the markets might start to look better, before I enter the stock. In the meantime I would look at a short-term income play again, but this time I would be looking bullish.
The Options Play
Trading at $17.10, I am looking for a move up in the stock eventually. So I am choosing to buy far out for time decay protection since I do not know when the stock will move up, but I do not look for it to happen soon.
Buy an October call with a strike of '17' (ITM) (priced at $1.14)
Sell an October call with a strike of '18' (priced at $0.65)
Net Debit to Start: $0.49
Maximum Profit: $0.51
Maximum Risk: Net debit
Maximum Length of Trade: 4 months
Reasoning behind the Trade
I believe the stock will turn up before year's end.
Buying '17' gives you more of a chance to capture a profit quicker.