November 9, 2011 / 8:24 PM / 6 years ago

Options players expect less drama from Cisco stock

(Reuters) - Cisco Systems Inc is normally a turbulent stock after earnings, but the options market is not expecting a wild ride following its results after the close on Wednesday.

Expectations are for a 6.5 percent move in Cisco’s stock price after it reports earnings, based on short-term options expiring by the end of this week.

But the market’s track record on the networking gear maker has not been great of late, underestimating double-digit percentage moves in the stock’s price after earnings in recent quarters.

Cisco has won cautious endorsement for its months-long overhaul, but now must convince Wall Street it can return to steady growth.

Traders have been looking at Cisco’s weekly front-month $18 straddle price, which is near the current stock value of $17.62. The weekly straddle, expiring this Friday, was priced at about $1.17 near midday on Wednesday.

A long straddle is a bet on volatility. It involves buying a put and a call with the same strike price and expiration date. Traders use prices on the straddle to estimate the option market’s view of the potential range of a stock, going into an event like earnings.

But the market has generally underestimated Cisco’s volatility.

“The average move over the past four quarters is about 13 percent and so the options market once again is pricing in a smaller move relative to what we have seen in Cisco’s history,” said Steve Place, a founder of investingwithoptions.com in Mobile, Alabama.

Options traders were caught off guard after Cisco reported earnings in February and August, when the stock far exceeded the swings the options market expected.

Place believes buying the weekly $18 straddle is a good trade because the options market has been wrong of late, so it pays to buy volatility.

Goldman Sachs Group on Wednesday recommended investors sell Cisco January puts to enhance returns, expecting post-earnings fluctuations of around 5 percent, closer to the historical norm for Cisco.

“As fundamentals become less concerning for Cisco, we’d expect the moves on earnings to be less dramatic,” GS derivatives strategists said in a report on Wednesday.

A return to pre-2010 average earnings stock moves of 5 percent would benefit options sellers as uncertainty in options remains elevated, Goldman said.

A midday look at Cisco option activity in the November $19 and $20 strike calls suggests investors are looking for the stock to remain at an earlier price level of $17.81 or drop after the earnings, said Patrick Mortimer, director of options trading at Pipeline Trading Systems.

Cisco option volume was 2.4 times the typical levels with about 180,000 calls and 119,000 puts changing hands in afternoon trade, according to Trade Alert.

Reporting by Doris Frankel; Editing by Jan Paschal

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