Stock Options To The Rescue! Cisco Systems (CSCO)

| August 16, 2012 | 0 Comments

IBM optionsToday we’re looking at an option trade on Cisco Systems to protect your profits after a big gain in the stock.

Here’s what happened…

Cisco Systems (CSCO) reported quarterly earnings this week.  The shares are up 7% to around $18.70 after profits and sales beat Wall Street estimates.

Here’s the deal…

Cisco is the largest computer networking equipment maker in the world.  They’re often seen as a bellwether for the industry and business tech spending.

CSCO earned 47 cents per share last quarter.  A 17.5% increase from the same quarter a year ago.  Their EPS came in ahead of the 46 cents analysts were expecting. 

Sales also grew 4.4%, albeit at a slower pace than their long term growth target of 5% to 7% per year.  Nevertheless, it was a strong performance considering the headwinds they faced from a weak European economy.

Here’s the kicker…

CSCO also announced a massive dividend hike.  They increased their dividend by 75%!

The new quarterly dividend of 14 cents per share launches their dividend yield to around 3%.  That’s nearly unheard of in the tech industry.

Amazingly, CSCO plans on returning 50% of free cash flow to shareholders.

Up until last year, CSCO didn’t even pay a dividend.  They were solely focused on growing the business.  And now they’re committing to paying out a huge dividend.

This is clearly a departure from what made CSCO the company it is today.  It remains to be seen how investors will react to CSCO as a dividend payer and not solely a growth stock. 

The higher payouts will likely attract new investors who are drawn to the stock for its big dividend.  But at the same time, CSCO could also lose some of its appeal to large cap growth investors. 

Here’s what to do now…

Let’s assume you invested $1,500 to buy 100 shares of CSCO at $15.00 per share at the low it reached in late July.  Their post earnings performance has generated a handsome $370 profit on your $1,500 investment.   

But don’t forget, the company is still facing headwinds from slowing economic growth.  And they’ve changed their business model from one that’s solely focused on growth to one that’s committed to returning capital to shareholders.

At this point, it’s a good idea to protect your gains.  Holding onto the stock and buying a put option will limit your downside.  And since you still own the stock, you’ll get to collect the fat dividend and still benefit from any additional upside in the stock.

Buy 1 CSCO November 2012 $18 put.

In essence, buying a put on a stock you own is like an insurance policy.  If CSCO falls below $18 before the option expires, you have the right to sell your shares at $18.

Right now, you can buy the November $18 put option for $0.70.  So the insurance costs $70.  Since CSCO currently trades for $18.70, the most you can lose on the stock is 70 cents per share. 

In a worst case scenario, investors reject CSCO’s new strategy and the stock takes a nosedive.  You’ll be able to sell the stock at $18 per share.  And you walk away with a 12% profit. 

On the other hand, investors could embrace the new high yielding CSCO.  In this case, the stock will hold onto its recent gains or even move higher. 

The put option will expire worthless.  You’ll be out the $70 you paid for the option.  But you’ll still own the stock.  You get to participate in any additional upside and collect the dividend.

As you can see, protecting your big gains in CSCO with put option gives you the best of both worlds.  You’re able to guarantee you’ll make a profit on the stock if it falls back.  And you still own the stock so you can collect the dividend and benefit from additional upside. 

Good Investing,

Corey Williams

Tags: , ,

Category: Stock Options To The Rescue!

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.