How I’m Trading Cisco Systems (CSCO) Earnings

11/10/2010 12:01 am EST

Focus: STOCKS

Steven Place

Founder, InvestingWithOptions.com

Cisco Systems (CSCO) reports today after the market close. I’m looking to potentially do a trade, but wanted to put some analysis out there.

Historical Bias

Now what makes this particular earnings event interesting is the earnings prior. CSCO is not the most volatile of names, and it generally doesn’t see large gaps into earnings. But when the company reported in August, it created a huge gap, and the options market got it completely wrong—it was the worst gap down since at least 2002.



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Overpricing the Move?

What I often see is after a huge post-earnings move, the report after that move will often have a large premium priced into the options. That is because option traders do have a memory, and they overprice the potential gap risk.

Looking at the weekly options, we can see the options market is pricing in about a 4.3% move by Friday. So that means as long as CSCO stays under $25.61 and $23.51, the option shorts will make money.

Comparing that expectation to the previous earnings event, it’s slightly higher by about .05%. So it seems that the options market is expecting a normalization in terms of earnings volatility, and it’s not expecting a huge 9% gap down again.

Have the market makers learned their lesson? Most likely, CSCO won’t see another gap like that, but it is interesting that the perception of risk is about the same, and it may be due to the overall market environment rather than overt earnings risk.

By Steven Place

Structuring trades around earnings can often be a difficult task, but you can learn about it from Steven Place here.

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