An Article I wrote in March suggested an options play on a pullback I expected on EMC. Here is the play I suggested.
The Options Play
Anticipating a pullback before it moves up, we are looking at a Bear Put Spread.
- Buy the July 2012 28 put option (priced at $1.78)
- Sell the July 2012 27 put option (priced at $1.42)
- Net Debit to start: $0.36
- Maximum Profit: $0.64
Reasoning behind the Trade
We are bullish long term on EMC but we really see a pullback here. Not only has it bounced off the 52-week high that offers strong resistance, but it also has a strong negative divergence that signifies the stock is weakening on this move up. It is not as strong as the last move. EMC has been over bought for a good three weeks so it makes sense that a pullback is coming.
As you can see by the chart, the trade lasted about 10 weeks before I made money on it. Since that period of time the markets have changed a lot and EMC has also been through an up and down time period. But I believe the stock is turning bullish now and I am not the only one who thinks this.
(click to enlarge)
Analysts Also like EMC
Brean Murray, Carret & Co. held firm to its buy rating for EMC with a price target of $32.00. What is the reasoning for keeping it a buy? This last half of 2012 continues to look like the stock will continue to increase in value and the EPS for the year looks like it could come in better than forecast. Gross margins will be the driving force behind the stock as it is expected to be higher than forecasts also.
Credit Suisse Group reiterated its Outperform rating, but lowered its price target from $35.00 to $30.00
UBS Investment Research initiated its rating on EMC with a buy and a price target of $30 because it believes earnings will continue to grow for the company. It expects the stock eventually to break out on new product strength.
2nd Quarter Earnings Rare Occurrence
In the Q2 report, EMC's EPS of $0.39 was in line with analyst estimates of $0.39 and it also beat revenue forecasts for the quarter, coming in at $5.31 billion versus the consensus estimate of $5.29 billion. Few companies have been able to do this and investors are taking notice. This might be a good place to put one's money!
Finally, the stock is in a formation that looks like it is ready to break out on the upside.
Double Bottom
The Double Bottom Reversal is a bullish reversal pattern typically found on bar charts, line charts and candlestick charts. As its name implies, the pattern is made up of two consecutive toughs that are roughly equal, with a moderate peak between. Although there can be variations, the classic Double Bottom Reversal usually marks an intermediate or long-term change in trend. Many potential Double Bottom Reversals can form along the way down, but until key resistance is broken, a reversal cannot be confirmed.
The Options Play
Presently trading at 26.27, I am looking at playing the break out of the double bottom. Now, there are two things I really need to keep in mind as I think about this. The first is that a double bottom could turn into a triple bottom before the formation is complete. Based upon the chart, I need 6 weeks' time decay protection for this. Secondly, it is not uncommon for these to dip back and then bounce up. If this happens I need another 3 weeks' protection. So 3 months should give me enough protection. So I am looking at a Bull Call Spread for October.
- Buy an October call with a strike of '27' (priced at $1.11)
- Sell an October call with a strike of '28' (priced at $0.70)
- Net Debit to start: $0.41
- Maximum Profit: $0.59
- Maximum Risk: net debit
- Maximum Length of Play: 3 months
Reasoning behind the Trade
- EMC looks like it can break out soon.
- Positive Earnings & Revenue was rare and analysts are bullish on the stock.
- 3 months should give us enough time decay protection and it is well within the price target.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
