Playing Cisco Into Earnings

 | Aug 13, 2014 | 12:02 PM EDT  | Comments
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I tend to think of the dinosaur tech names as non-movers around earnings. The truth is, some are, but then again, some aren't. Cisco (CSCO) tends to fall into the "some aren't" category. The stock chart is worrisome for bulls as it has a head-and-shoulders pattern; however, there is a wedge there as well. 

As worrisome as the price pattern and secondary indicators are, it has created a trade setup into earnings. The chart is poised for volatility, but what does history say?

Cisco (CSCO) -- Daily
Source: StockCharts.com

Over the past four reports, the stock has seen a close greater than 6% three times and moves of more than 8% from the previous day's close three times as well. The straddles are priced for a 4.9% move and we've seen moves over 5% at some point during the post earnings trade day the last four reports in a row. Holding into the close is a bit of a different story, but I do have a two-pronged approach to this trade.

Rather than just buy a single straddle, I am going to use a ratio approach. I am buying two August 29 $25 straddles and selling one August 16 $25 straddle against it for about $1.55. If the stock does nothing, then the short straddle should expire nearly worthless and I'll need to see about a 3.2% move over the next two weeks to get in-the-money. I think it's possible.

Cisco

While I'll "lose" $0.18 on a big move, it will just be $0.18 less profit. If CSCO moves $2, then I'll have a $2 value against $1.55 risk as opposed to $2 value against $1.37 in risk if I were just to buy a single August 29 straddle. I believe the $0.18 is worth offsetting a significant portion of the loss if the stock does nothing on earnings.

For a trader who is expecting a decent size move, a more aggressive way to play this is with more traditional ratio spreads. For instance, go long one August 22 $26 call and $24 put while shorting two each August 16 $27 calls and $23 puts for around $0.22. This trade needs a 4.9% to be in the money; it maxes out on an 8% move and starts to lose money on a move over 11%.

Of course, a move smaller than 4.9% will likely result in a loss. Combining it with the above trade eliminates the short leg of a trade, but it does increase the cost and required move for a break-even trade.

I see this type of trade as more of a lottery ticket. Although it is tempting, I favor the unlimited upside of the previous trade vs. the lower capital outlay of this trade.

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