Will Cisco Run With The Bulls?
Understandably, Cisco
(
CSCO |
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PowerRating)
options are topping most active lists on the Amex and CBOE and running a close
second behind WorldCom
(
WCOM |
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PowerRating) on the PCX. As of 11:40 am CST (CSCO @
55 ½), the volume is nearly 110,000 contracts. Implied volatilities are about
89% in the near-term November options and 70% for the December options. With
three-month average volatility at 67%, you are paying pretty high juice (option
slang for premiums) for the Novembers.
One way to somewhat negate the massive volatility jump in Nov is a simple
calendar spread, like the one we looked at in Qualcomm
(
QCOM |
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PowerRating) last
week. The Nov — Dec 55 calendar is trading for 1 7/8, while the Nov — Dec 60
(slightly more bullish) is trading for 1 1/2.
The beauty of the calendar spread is that it allows you to sell the higher
volatility November options and cover them with the more moderately priced
December options. You are not naked any contracts and have defined the total
risk upon entry.
After the earnings are announced this evening, the volatility will get smacked.
What that means in plain English is the November options will revalue at or near
the 67% three-month average. At that volatility level, the 55 calendar would be
worth 2 3/8 and the 60 calendar would be worth 2 1/8. If you push the time out
five trading days until next Monday, the spreads each would expand to 2 3/4 and 2
1/2 respectively.
The risk is that CSCO blows out the number and runs to 70 and the 55 spread
shrinks to 1 1/4, or CSCO dumps to 40, at which the 55 spread drops to just 3/4.
We don’t think either extreme is likely, but investors should always consider
the worst-case scenario rather than just the best. Good luck and profitable
trading.
*Note: Our QCOM Nov — Dec 70 call spread has further expanded out to
3 3/8, a 35 % profit in about a week.
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