MorningWord 6/20/14: Oracle and Trying to See the Future – $ORCL

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Back in early April, following what were less than stellar fiscal Q3 results, I made a bearish trade on ORCL when the stock was $40 (here) predicated on sluggish growth, ok valuation and positive sentiment for what I deemed to be the wrong reasons.  With the stock down 6% in the pre-market after last night’s weak Q4 (one that is expected to be their strongest seasonally) and squishy guidance, the stock is now below my long put strike, but with just 7 hours until my trade expires.

This is far from a victory lap, as the trade was nearly a total loser  prior to last night’s print, and it would take a bloodbath in the stock today for me to get out unchanged.  But the situation highlights the difficulty in making directional bets with long premium in a low volatility environment.  There are a lot of things you have to get right, direction first and foremost, magnitude for the move, and then timing.

Seems easier just to buy or sell stocks right??  Well, let’s break it down, here was the trade from April 4th:

TRADE: ORCL ($40) Bought to Open June 40/37 Put Spread for 1.00

-Bought June 40 Put for 1.60

-Sold June 37 Put at .60

As I write the stock is trading at $39.70 in the pre-market.  I am only going to be trading out of the June 40 puts today because there is nearly a 100% probability that the June 37 puts expire worthless on today’s close.

But let’s look at where the stock went in the two and half months since I initiated the trade and how the trade might have worked out if I had shorted the stock at $40.

Here is a chart of the last 70 trading days since mid March:

ORCL 70 day chart from Bloomberg

ORCL 70 day chart from Bloomberg

Let’s say I bought 10 of the June 40/37 put spreads for $1 when the stock was $40.  My maximum risk was $1000, and my maximum gain was $2000 if the stock was $37 or lower or today’s close with my maximum loss of $1000 if stock was above $40.  Not bad odds for an at-the-money contrarian play with a duration of two and half months.

If I had shorted 1000 shares of stock at $40 on April 4th, the trade would have been a winner for a period of time, in April, and I would have had  choice to take profits or play for a larger move.  But as soon as the calendar turned to May the trade became a loser in both scenarios and then the question of risk reduction or cutting my losses would have come into play.  If I were short stock, I would have had to start considering to cover at $41 (purple line), and then ultimately having to pull the trigger at $42 (red line) as the stock made new 14 year highs:

ORCL 6 moth chart from Bloomberg

ORCL 6 moth chart from Bloomberg

With my options trade, I had already set my stop to the upside at $41 by only paying $1 in premium to start.  Did I considering cutting my losses when the stock first got there in early May when the spread had lost half its value? Yes I did, but I thought about my thesis and not much had changed, so I stayed the course as I had already made my risk management decision by the way that I expressed my view.

Now many would argue that the price action was telling me that I was wrong despite my conviction on the fundamentals or sentiment, but again, I was not naked short the stock.  To button this up from a trading perspective, I never want to see long premium trades expire worthless.  It is obviously the worst possible scenario for any trade, and if the Q4 earnings were not the catalyst that I had identified, I would have probably cut the position long ago.

Today’s pre-market price action in the stock confirms a couple points about my thesis –  sentiment was overly bullish & fundamentals are still weak, but I AM STILL WRONG.  Timing is not everything in trading, but it’s almost everything.

Wednesday on Fast Money I had a bull bear debate on ORCL with formidable opponent Josh Brown (The Reformed Broker : read his book Clash of the Financial Pundits, I did and thought it was great.) I was the bear, watch here:

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Here were my notes going into the Street Fight:

1. Price Action: Stock has been clear beneficiary of rotation into large cap tech in 2014, up 11% on the year, has not benefited from revenue growth as there was none last year and a large part of single digit earnings increase in 2013 was aided by share buybacks
2.Recent Results: When the company reported their fiscal Q3 results in mid March they missed consensus on sales, earnings and margins, citing shift to…… wait for it CLOUD.  Company guided the current quarter inline. While the financial bar is not high, the stock might be a tad ahead of itself trading at 14 year highs and 10% away from the all time highs. 
3. Valuation: PE nearing 10 year highs, trading almost 15x current year earnings that are expected to grow only at 8%, with sales growth of a measly 3%.
4. Growth: company is a serial acquirer, they have made 100 acquisitions worth $50 billion over the last 10 years. They have no organic growth.  Media reports of late suggest they are going to pay $5 to $6 billion for Micros Systems, a company that sells point-of-sale system software and hardware to the hospitality and retail sectors.  Company has modestly higher growth, and some analysts suggest at best would be mildly accretive in first year.  Not a great use of their excess cash ($13 billion net of debt)
Not a buyer here, I suspect you get a shot closer to $40 in the coming months.
So you get my point.  My timing in April was lousy, and if I had taken this view on Wednesday I would have had a nice trade this morning.  But as you know there are no crystal balls in trading, and we can only trade what is in front of us. As I was wrong to the tune of 6.5% from early April, a bull on yesterday’s close would have been wrong the same amount in just a day.  Will the stock bounce?  Probably, that’s what it did after disappointing Q3, so maybe it’s a buying opportunity.  But wrong is wrong, and to avoid being really wrong when trading events one needs to define their risk and risk what they are willing to lose or trade stock with stops.