ZAGG: Why We Want Downside Exposure

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Zagg (ZAGG) is a company that got its start selling cases and screen protectors for mobile phones. You know, the thin pieces of plastic that you can buy directly on Amazon from companies in China for $0.99. ZAGG diversified more recently into earphones, but that is also a crowded space and they are at least one or two steps behind companies like Skullcandy (SKUL), which has followed the trend of linking up with celebrities, sports franchises, and DJs.

ZAGG CEO Robert Pedersen resigned unexpectedly on August 17 after selling a significant portion of his shares to meet margin calls and in order, he said, to "focus on his family, his church and a family foundation." On Tuesday, a New Jersey law firm announced it was investigating whether ZAGG had violated federal securities laws related to these events.

 
ZAGG and SKUL One-Year Performance
Source: TD

The stock is down nearly 50% on a yearly basis. Options markets, however, have not reacted strongly to recent troubles, as both one- and two-month implied volatility estimates are within the bottom third of their two-year ranges. These moderately low volatility readings suggest that traders do not anticipate that price swings in the shares will be more dramatic than they have tended to be in the past. It is worth noting that two-month implied volatility has ranged between 50% and 140% since 2010 - even in quiet markets ZAGG shares tend to be volatile.

We like a long SKUL / short ZAGG pairs trade as a longer-term stock position, but to get a tighter reign on risk we can buy a vertical put spread.

Trades: Buy to open ZAGG October 7 puts for $0.70 and sell to open ZAGG October 6 puts at $0.30.

When CEOs resign suspiciously from dubiously competitive companies and regulatory actions or law suits are on the horizon, it often pays to buy downside exposure when it is relatively cheap.

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At the time of publication, Jared Woodard held a position in SKUL.