My proprietary trading method works in any market condition or direction. I begin with a market overview. From there, I drill down into the fundamentals of a particular sector that aligns with my macro view. Then, I run detailed screens on a particular company’s fundamentals, the stock’s technicals, and finally, its options.
Each of these tests gives me a bullish or bearish ranking. The strongest trades occur when all of the above metrics align, and today’s bearish trade does just that.
The stock market appears to be in the midst of a long overdue correction. While this should provide buying opportunities for many stocks, it will also act as selling propellant for those stocks that are on shaky fundamental and technical ground.
A decade ago, before anyone had heard of the iPhone, the “it” phone was the Motorola Razr. As consumers made the switch to smartphones, the company began producing Android smartphones and Bluetooth accessories. But, in 2011, the mobile phone segment was split off into its own company, Motorola Mobility, which was purchased by Google (NASDAQ: GOOGL) and later sold to Lenovo.
What was left was Motorola Solutions, which sells communications equipment such as scanners and two-way radios to enterprise and government customers.
The company is struggling with declining product sales and revenue, and its latest earnings report was a disaster, missing estimates on the top and bottom line.
Second-quarter revenue was down 7% year over year to $1.4 billion while analysts had expected $1.6 billion, with product sales declining 10% tn. Adjusted earnings per share (EPS) of $0.47 also fell short of the company’s projected range of $0.58 to $0.64.
MSI forecasted more of the same for the third quarter, with sales expected to decline 7%-9% year over year. It projected adjusted EPS of $0.35 to $0.41, well below the $1.02 analysts has expected. Since then, the consensus estimate has been lowered to the high end of the company’s range.
For the full year, Zacks consensus earnings estimate is $2.24 per share. MSI is currently trading at 28 times that estimate compared with a P/E ratio of about 19 for the S&P 500.
Earnings are expected to grow at a measly 2% a year on average for the next five years, making its PEG ratio and incredibly bloated 14. The PEG ratio compares a company’s P/E ratio to its earnings growth rate, with 1 being considered fair value.
MSI hit a high above $68 in May before beginning its descent. On Aug. 5, the company reported disappointing Q2 results before the bell, causing shares to gap down 4%. The selling continued, taking MSI to a low of $58.61 on Sept. 5.
On Sept. 8, shares jumped 3.6% on a large block trade and no apparent news. They continued to move higher from there, perhaps due to rumors of the compay’s pension restructuring.
On Sept. 25, it announced plans to reduce its pension obligations by $4.2 billion. The company said it intends to purchase a group annuity contract from Prudential Financial (NYSE: PRU), transferring $3.1 billion in liabilities to the life insurer, which will pay and administer future benefits to roughly 30,000 retirees. Motorola also said it will offer a lump-sum benefit to some employees.
If it weren’t for the pension restructuring, I believe shares would be closer to the $50 mark today. The reality is that Motorola simply had to do something with its underfunded pensions. While this plan removes a degree of uncertainty and lessens the company’s liability somewhat, the deal doesn’t add major income.
September’s rally looks way overdone, and it sets us up for a great bearish entry.
The stock remains in a bearish channel, but after breaking above its 50-day moving average and trading to its upper Bollinger Band, it appears overbought.
Another bearish sign is that MSI failed to close the earnings gap from Aug. 5.
Shares are currently below the 200-day average, which also coincides with the 23.6% Fibonacci level at about $65. This level should act as strong resistance and will help determine our stop-loss for the trade.
Third-quarter earnings are due out on Nov. 4, and my models point to another disappointment, which should act as a downside catalyst. I expect MSI to trade back down to the $60.90 level, which is near the 50% Fibonacci retracement from the past year’s range and just below the close of the Sept. 8 rally.
That target is about 2% below the stock’s current price, but using options we can limit our risk and leverage that move into 20% profits.
MSI Put Option Trade
Today, I am interested in buying MSI Nov 67.50 Puts for a limit price of $5.50.
Risk graph courtesy of tradeMONSTER.
This put option has a delta of 82, which means it will move roughly $0.82 for every dollar that MSI moves, but it costs only a fraction of the price of the stock.
The trade breaks even on expiration at $62 ($67.50 strike price minus $5.50 options premium), which is less than 1% below current prices.
If MSI hits my downside target of $60.90, then the put option will be worth at least $6.60. Once you enter the trade, place a good ’til cancelled (GTC) order to sell the options at that price.
Recommended Trade Setup:
— Buy MSI Nov 67.50 at $5.50 or less (use limit orders)
— Set stop-loss at $2.50
— Set initial price target at $6.50 for a potential 20% gain in two months
If you have a question or comment about today’s strategy, please send it to[email protected].