Cisco Shock and Awe
Cisco Systems
(CSCO) - Get Report
shares opened 16% lower this morning, trading down $3.80, at $20.69 ~10:20 a.m. EDT, as investors bailed out on disappointing revenue projections from the company. While option volume was heavy leading into earnings, the markets seem to have badly misjudged the potential for a move of today's magnitude, with premiums ending the day yesterday suggesting a much smaller gap was expected.
A quick look at the 24 strike weekly straddle shows $1.32 would have bought you a position that would break even at $22.68 to the downside, making today's $20.50 level a $2.00 winner had you done the trade. Quantitative analysts and mathematicians will point out that the implied earnings standard deviation was about 6%, equivalent to a 95% probability of a move less than 12%. Those 'quants' would call today's move a 'three-sigma' event--something that happens less than one time in 100, although that explanation does little to dull the pain if you are on the wrong side of the trade.
Examination of early post-earnings flow shows traders may be looking for a bounce in CSCO shares, as November 21 calls lead the flow in offer-side action, followed by sellers of November 20 puts. While I am a bit cautious on the general market levels at this time, I think the December 20/22 call spread for $0.78 would be a reasonable way to join the recovery view for Cisco.
Trades: Buy to open 10 CSCO December 20 calls for $1.08 and sell to open 10 CSCO December 22 calls at $0.30.
At the time of publication, Henry Schwartz held no positions in the stocks or issues mentioned.
Henry is the president of Trade Alert LLC, a provider of real-time options analysis tools to leading Wall Street firms. His systems analyze hundreds of thousands of transactions per second to help professionals identify and interpret market activity in real time, supporting informed trading decisions and intelligent idea generation.
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