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Options Trading Strategies in Today's Tech Wash-Out Names

|Includes:Akamai Technologies, Inc. (AKAM), CRM, CTXS, EQIX, FFIV, RAX, RHT, RVBD, VMW, XLK

 As the market managed to basically trade flat on the day due to strength in commodity related stocks, an absolute liquidation was in effect in some of this year's top gaining Technology stocks, a focus on the cloud computing, networking, and storage industries.  As the market traded on light volume, one of the lightest volume days in 2 weeks, many of these names traded more than 4 times average daily volume.  Much of the weakness was attributed to reduced Q3 guidance from Equinix (NASDAQ:EQIX), as many of these names traded in sympathy with the comments seen as a potential headwind across the entire industry.  Although many of the stocks were defended by Tier 1 firms intraday, most of them failed to catch much of a bid and continued lower much of the day, the top names losing anywhere from 7.5% to 14%. 

Now, it is impossible to blame all of that price action on the guidance from Equinix (EQIX), a Company that goes unnoticed on most trading days.  There was a bigger force at play, a liquidation day with individual traders and funds taking profits in some of the top performers from 2010 with uncertainty heading into Q3 earnings reports.  Much of the cash raised will head to the sidelines, while some will aim to be reinvested in stable value names, or high yielding dividend stocks.

Often, moves such as the one seen today are seen as capitulation days, but it is the type of move that will keep new money "scared" from jumping in anytime soon, and I cannot imagine many willing to hold through earnings.  Therefore, I feel there is more downside in store for these stocks, although not an extreme move, and the upside is likely capped through year end due to uncertainty.  The stocks are likely to trade within the low to high range seen in today's trade for awhile, and should calm after volatility in the names soared.

The names that were the focal point today were Akamai (NASDAQ:AKAM), Salesforce (NYSE:CRM), Citrix Systems (NASDAQ:CTXS), F5 Networks (NASDAQ:FFIV), Rackspace Hosting (NYSE:RAX), Red Hat (NYSE:RHT), Riverbed Tech (NASDAQ:RVBD), and VMware (NYSE:VMW).  The cloud computing names have been big winners this year simply as a growth story, and the story is still in its infancy, with a ton of potential going forward, but valuation has gotten to a "bubble" point.  Networking and Storage names have been great performers for a different reason.  Although the growth is there as well, the names have mainly been trading with a "takeover premium" as consolidation in the industries has seen a few high premium M&A deals, and that has created an underlying bid in the names, as every name is seen as a potential target for the larger companies yearning for growth that cannot be created internally.

All of these names are considered very rich on valuation as on average the stocks trade 40X forward earnings, PEG of 5, 8.5X sales, 13.65X cash, and 32.5X free cash flow.  The names also have fairly high short floats with Rackspace and VMware having the largest short float.  Stocks that trade at lofty valuations are subject to volatile price moves on any signal that growth may be slowing, because the slightest change to growth estimates can have a large impact on price targets in the Street's valuation models, whether is on a discounted cash flow model on using relative valuation models.  A look at the valuation metrics for these names can be found in the table below:

Valuation Metrics of Tech Stocks

Click to enlarge

Another impact with today's moves was seen in the options markets where put volume traded at more than 10X daily average volume in many of the names, and volatility soared.  Interestingly, many of the names saw larger moves (relative) in October implied volatility than in the further out months, and with the companies all reporting Q3 earnings for November options expiration, there is a disconnect with October volatility appearing rich compared to November implied volatility.  A table of the put activity and the changes in volatility can be found below:

Tech Options and Volatility View

Click to enlarge

There are a variety of ways to trade these names going forward and into earnings season following today's action, depending on your view of where price and volatility are heading.  My personal view is that a move like the one seen today is going to put a top in shares at recent highs, while the downside will be somewhat limited as well as investors still crave growth stocks in a market where most companies are seeing a slowdown going forward.

Strategy 1: Ratio Put Spreads

The ratio put spread involves buying one put and selling two (or whatever ratio desired) further out of the money puts.  The spread does require margin due to being naked short puts, but it is a strategy I love to use when stocks have well defined support levels.  Also, to lessen the risk you can cash-secure the naked end of the puts at the price level you would be willing to get long stock.  I prefer to put these strategies on for net credits, so the maximum profits are realized on a move lower in shares to the level where the puts are sold, while you can also keep the credit if shares were to rebound and head higher, also a chance to make a nice percentage gain as Volatility and Time Decay kick in closer to expiration and the spread price widens.  The strategy is bearish on volatility and can reap large ROI just through the changes in Vega/Theta, although large losses can occur if shares are completely crushed.

It is best to look at some examples, potential trades with the names discussed above:

Citrix Systems (CTXS) has gap support at $52.50 while the 200 day moving average at $50 is also a support level, as well as the psychological $50 mark. 

The December $55/$50 1X2 Ratio Put Spread at a Credit of $0.50 Per Spread has the following critical P/L Levels: Max Profits on Move to $50; Profitable with Shares Above $44.50, Keeping the Credit on a Close Above $55 in December.   The Trade View is below:

Citrix (<a href='' title='Citrix Systems, Inc.'>CTXS</a>) Ratio Put SpreadClick to enlarge

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F5 (FFIV) has a gap to fill down to around the $77.50 level ,while the 200 day moving average is at $75, also a level where shares started to breakout and really went parabolic. 

The December $80/$75 1X2 Ratio Put Spread at a $0.30 Credit Per Spread has the following critical P/L Levels: Max Profits on Move to $75, Profitable from $69.70 and Above for Shares, Keeping Credit on Close Above $80 in December.  The Trade View is below:

F% (<a href='' title='F5 Networks, Inc.'>FFIV</a>) Ratio Put Spread

Click to enlarge

Strategy 2: Iron Condors

The Iron Condor involves the combination on a bear call spread with a bull put spread and is used when volatility is expensive and you feel shares will remain in a range.  An example would be:

Riverbed Tech (RVBD) topped out around $49 before dropping 8.35% today to $44.47, while the 50 day EMA at $41 and the 100 day EMA at $37 are seen as support levels to the downside.

An Iron Condor in December involving the sale of the December $47/$50 Call Spread as well as the December $38/$35 Put Spread results in a net credit of $1.70.  The spread is profitable from $36.30 to $48.70, while the maximum loss is $130 with the max gain the credit of $170 ($3 Vertical Spreads).   The Trade View can be seen below:

Riverbed (<a href='' title='Riverbed Technology, Inc.'>RVBD</a>) Iron Condor

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Strategy 3: Double Diagonal Spreads

The Double Diagonal may be the best strategy here as the October IV is rich compared to the November IV considering the next major catalyst will be in November.   Examples are as follows:

Salesforce (CRM) will face major resistance at $115 in the near term, the 20 day EMA and today's high, while today's low of $97.50 should lend support, after filling its earnings gap from last quarter.  The $95 mark is also a level that shares broke out at previously and is seen as a major support level.

With that said one could sell the October $115/$95 strangle at a $1.55 credit and buy the November $130/$80 strangle at a $2.30 debit for a net debit of $0.75.  The Trade View is as follows (Observing October Expiration P/L)

Salesforce (<a href='' title=', Inc.'>CRM</a>) Double Diagonal

Click to enlarge

VMware (VMW) shares will see $85 as major resistance, the 20 day EMA and today's highs, while the 100 day EMA at $75 is a likely support level.

In this trade one could sell the October $80/$75 strangle for a $2.65 credit and buy the November $95/$75 strangle at $5.60, a net debit of $2.95.  The Trade View is as follows: 

VMware (<a href='' title='VMware, Inc.'>VMW</a>) Double DiagonalClick to enlarge






Disclosure: No Positions as of Writing

Disclosure: No Position