Trade Update: ORCL Closing March Part of Calendar

Trade Update: (Straddle/Strangle)

With ORCL at  30.60 following a decent earnings report we’re covering the March straddle at .87 as it is simply a short delta play at this point. We’ll hold onto the April strangle for now. Vol in April has been lowered to 21ish which seems way too cheap and possibly an overreaction, but nevertheless so dollar cheap worth a shot to hold on and see what happens.

Straight Calendar Trades Update

Looking at the straight Calendar Spreads the Bullish trade can be taken off for 40c and the Bearish trade can be taken off for 25c despite being wrong on direction, which goes to show you that there are very few ways to lose when selling 70 vol and buying 30.

 

 

Original Post March 20th

ORCL reports its fiscal Q3 after the close tonight and the options market is implying about 5.3% move following the report, which is basically inline with the 4 qtr avg move of 5.37%, but rich to the 8qtr avg of about 4.64%.  See Bloomberg Expectations below.  

-Wall Street analysts remain fairly bullish on the name, despite the disappointing fQ2 and forward guidance reported back in mid December, with 28 Buys, 13 Holds and 2 Sells.  Short interest remains very low at less than 1% of the float.

-The most recent downgrade came from Pacific Crest Analyst Brendan Barnicle who went from a Buy to a Hold and lowered his price target from $35 to $32, about 10% higher than current levels.  Here are a few of the highlights of his call:

We downgrade Oracle to Hold based on: i) challenges with the engineered systems strategy; ii) building threats to the core relational database business;and iii) recent checks that were underwhelming.

Downgrade to Hold: Tactically, our recent work suggests the engineered systems strategy is facing greater challenges and in general our field work has been underwhelming, though

not as negative as last quarter. We also have increased concerns that the relational database is facing multiple threats including SAP‘s HANA, increased adoption of SaaS by enterprise customers (especially Salesforce.com and Workday) and the potential risk of disruption from new approaches to analyzing large volumes of unstructured data.

Challenges for the engineered system strategy. Our recent work suggests that the company is facing greater challenges with this strategy and that adoption of Exadata has moderated, Oracle Database Appliance (ODA) adoption has not been as strong as expected and Exalogic is still seeking a viable use case. We are concerned that the strategy is not playing out to plan with implications for growth. Building threats to the core relational database business. SAP is on the cusp of launching HANA under SAP BW and so is starting to offer customers an alternative to the relational database for part of their footprint. It’s a first step and SAP has big ambitions for the technology which, if successful, creates tail risk for Oracle.

In addition, the success that leading SaaS vendors such as Salesforce.com and Workday are having in large companies creates risk for some of Oracle’s large application assets (notably Siebel and PeopleSoft) as well as database revenues.

Our $32 PT is 12X our CY13 EPS estimate at the end of CY12. This multiple is in-line with the large cap tech median. ORCL NTM EPS troughed at 10X in 2009 and its 3-year average is 14X.

 

From a Technical perspective, the stock has filled in the entire gap from the Q2 miss and and is now resting right on it’s 200 day moving avg at about $29.75.

1 YR ORCL Chart from

 

The stock is also sitting at basically the mid point of the range btwn the October highs of about $34 and the December intra lows of about $25.  This appears to be a relatively indifferent level, and one that could go either way depending apon the magnitude of a beat and raise or lowered forward guidance.

MY VIEW: Trading at about 13x fiscal 2012 earnings the stock trades fairly rich to its large cap tech peers MSFT at ~12x, INTC at 11.3x and CSCO at 11.1x.  SO the stock is slightly rich at current levels, given current earnings estimates.  Q2 is obviously old news and barring a disastrous Q3, the company should be able at the very least to meet the already lowered guidance.  If they are able to be beat and raise I think there is a strong likelihood that the stock sees a bit more than the ~5.3% implied move, and likely tests resistance at about $32.  But if as Pac Crest suggests the company has hit a some roadblocks in their strategy, and the company has its second consecutive disappointment there is a strong likelihood that the stock would be down about 10% retesting the december lows as the stock will finally be re-rated with a lower growth profile.

Volatility Skew

There is a huge skew between vol in options in March and April. March options, which expire on Friday are at about 68 vol right now. April, which expire in just over under a month are at about 30 vol. See here:

Monthly ORCL Skew from LiveVol Pro

 

We want to take advantage of a huge skew between front month vol and the next month out. Historically ORCL implied volatility is in the mid to high 20’s with spikes much higher like we see in April:

2 YR Vol chart from LiveVol Pro

 

TRADE: ORCL (29.86)

Sold Mar 30 straddle at 1.62
Bought Apr 29/31 Strangle for 1.32

received .30 credit for the structure

Best case scenario stock moves little from where it is. The March 30 straddle will be trading close to parity tomorrow. The Apr will come in a little assuming a 25% vol crush in April. Under this scenario of the stock doing an inside move you now own the April strangle for a credit.

Your worst case scenario is an expected move in the stock where your front month straddle trades at around the price you sold it, but your back month strangle does not increase in price due to vol coming in in April. But in this scenario you lose money overnight but still have a chance to make it back in the following month if the stock goes outside your strangle strikes significantly.

 

One could simplify this by picking a direction and doing a straight calendar.

Bullish Calendar:

Buy Mar April 31c Calendar for .22

Sell March 31 call at .39
Buy April 31 call at .61

Bearish Calendar:

Buy Mar April 29p Calendar for .22

Sell Mar 29p at .42

Buy April 29p for .64

 


TRADE Idea 2:  Low Premium way to play for a re-test of the $26 level after the Q2 disappointment in Dec:

ORCL $29.90: Buy the April 28/26/24 Put Fly for .21
-Buy 1 Apr 28 Put for .43
-Sell 2 Apr 26 Puts for a total of .28 (.14 each)
-Buy 1 Apr 24 Puts for .06
Break-Even on Apr Expiration:
Profits btwn 27.79 and 26 make up to 1.79, payout trails off btwn 26 and 24.21, while your max gain is at 26, make full 1.79 or 8.5x your money.
Loses of up to .21 btwn 27.79 and 28 and btwn 24.21 and 24, with max loss of .21 below 24 and above 28


 

BLOOMBERG PREVIEW

Oracle 3Q: Checks Mixed on Somewhat Muted IT Spending By Sarah Gill March 20 (Bloomberg) — Oracle expected to report 3Q postmkt today:

ESTIMATES

• 3Q adj. EPS est. 56c (54c-58c)

• 3Q rev. est. $9.02b ($8.89b-$9.11b)

• 4Q adj. EPS est. 76c (72c-80c)

• 4Q rev. est. $11.2b ($10.7b-$11.5b)

• ORCL forecast 3Q software license growth 0%-10% in U.S. dollars; 2%-12% in constant currency

• ORCL forecast 3Q hardware product rev. down 5%-15% in U.S. dollars; down 4%-14% in constant currency (doesn’t include hardware support rev.)

• ORCL typically gives rev., EPS, new software, hardware license rev. growth forecasts on conf. call

WHAT TO WATCH:

• ORCL likely to at least meet expectations, ests. may be lower after last qtr’s miss; forecast, end-market demand commentary likely largest movers of stock near-term: JPMorgan, March 19

• ORCL channel checks mixed on muted IT spending environment, more maintenance spending instead of new projects; Exadata, Fusion Middleware showing tangible signs of traction: Piper Jaffray, March 20

• NOTE: ORCL fell 12% Dec. 21 after Dec. 20 postmkt forecasting 3Q adj. EPS, rev. below ests, reporting 2Q adj. EPS, rev. that missed

• ORCL has missed adj. EPS 1 of last 4 qtrs, missed rev. 1 of last 4 qtrs, shrs have fallen day after 2 of 4 qtrs • ORCL up 16% YTD vs SPX up 11%

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