Cisco: Make 3.2% In 3 Months By Waiting

Jul.18.12 | About: Cisco Systems, (CSCO)

Cisco systems Inc. (CSCO) is giving us the opportunity to make a 3.2% gain in only 3 months, by doing nothing. This comes out to a very respectable 12.8% annualized.

The opportunity

This type of opportunity does not always present itself to us. When markets are more volatile than usual and when a specific stock is even more turbulent, you can take advantage of this opportunity in the options market. Options become more expensive when volatility increases. This is a great time to be an option seller, not an option buyer.

CSCO, a classic blue chip has been in the eye of the storm lately. The company guided for a slow next quarter and warned that technology spending could take a hit in the coming months. The company CEO, John Chambers, attributed the grim outlook to the macro-economic uncertainty surrounding the European debt crisis that is causing customers to remain cautious in their capital spending. As a result of this, the stock plummeted and remained in the $16 area since. The chart below tells the story.

A matter of valuation

As a matter of a trading principle, we do not chase trash stocks just to sell calls on them. We will only buy premium stocks that we are willing to hold. Only then, will we sell call options on them.

Cisco is not the only cheap blue tech in the park. In fact, there are currently many tech giants that trade at absurdly cheap companies. What distinguishes Cisco from the rest is the abrupt decline in share price that the company suffered. This decline brought Cisco well into the value territory. The table below highlights the opportunity in the big tech sector.

  Cisco Microsoft (MSFT) Intel (INTC) International Business Machines (IBM) Oracle Corporation (ORCL)
Forward P/E 8.5 9.7 9.6 11 10.25
Price/Book 1.7 3.6 2.7 10.2 3.3
Operating margin 22.7% 38.4% 31.6% 20.6% 37.87%
cash per share $9 $6.9 $2.73 $10.7 $6.28
Current price $16.22 $29.66 $25.38 $183.6 $29.92
Click to enlarge

By looking at the table above, Cisco stands out as extremely cheap. Not only that, but you should consider that approximately $6 per share of Cisco is net cash (debt is deducted). This actually means that you are paying only $10 for the whole operation of CSCO, which is 5 times its annual earnings. Incredibly cheap.

How to execute the trade

We need to buy the underlying asset (shares of CSCO) and sell calls on this position. This strategy is called a 'covered call' . We will sell call options at the nearest strike. Since CSCO is now trading at $16.22, we will sell the October calls at the 17$ strike. They are now trading for $0.52. If you buy 100 shares of Cisco for a total of $1,622 you can sell one call option and pocket $52 immediately.

Trading instructions

Buy 100 shares of CSCO up to $16.8 a share. Sell 1 CSCO October call at $17 strike, for no less than $47. You can trade any amount you like in the multiples of 100. You can repeat this trade all over again in 3 months.

Disclosure: I am long CSCO.