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Three Ways to Trade Qualcomm

How to play QCOM bearishly, with earnings just a few weeks away

by 6/28/2012 10:11:02 AM
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Let's be blunt: we don't like tech stock Qualcomm, Inc. (NASDAQ:QCOM - 55.07). The shares have turned significantly lower from their March/April highs near the $69 level, guided lower by resistance at their 10-day, 20-day, and 40-day moving averages. QCOM also recently broke below the $58-$60 neighborhood, which could now resume its prior role as a long-term technical ceiling.

Even more troubling, from our contrarian perspective, is the surprising amount of optimism that's still directed toward this downtrending stock. Analysts have graced QCOM with no fewer than 26 "strong buy" ratings, plus five "buys" -- compared to zero "holds," and only one "strong sell." Considering the equity's steep slide on the charts in recent months, this overwhelmingly bullish configuration opens the door for plenty of potential downgrades. A round of negative notes from this group could drag QCOM even lower.

QCOM daily price chartBut how do you play your bearish convictions on QCOM right now -- particularly with the company slated to report earnings on July 18, just ahead of front-month expiration? Well, that depends on a few different factors, including your personal risk tolerance, and how much cash you're willing to invest in the trade upfront.

If You're... Bearish, but Mousy

Buying an in-the-money put on QCOM has some obvious advantages. Your risk is clearly defined upfront, as is your potential profit. Plus, opting for in-the-money puts means that you have some intrinsic value baked right into your contracts. In essence, this means that (a) you have a bit more wiggle room for the stock to move against you before the trade goes belly-up; and (b) your put will gain value more rapidly than its lower-delta counterparts, should the directional move play out as expected.

For example, you could buy QCOM's July 57.50 put for $4.05. You'll be poised to profit on a move below $53.45, with $4.05 representing your maximum potential loss on the trade. (And you'd only realize that maximum loss if QCOM rallied to $57.50 or above prior to July expiration.)

If You're... Bearish, but Lacking Direction

The prospect of an imminent earnings report is more than enough to inspire some event-related ambivalence in even the most confident of traders. For those who are bearish QCOM -- but wary of a possible post-earnings pop -- a bearishly slanted straddle allows you to play both sides of the fence. You'll obtain all the same benefits listed above by purchasing an in-the-money put, but the addition of an out-of-the-money call at the same strike means that you can profit even if your directional forecast was dead wrong. The trade-off here is that you're paying double premium ahead of earnings, which can get pricey.

For example, you could buy that same July 57.50 put for $4.05, and simultaneously buy a July 57.50 call for $0.67. This brings your net debit -- and maximum loss -- to $4.72, which is a little steeper than the straightforward put buy. You'd need QCOM to close below $52.78 to profit from your bearish play, but you're also positioned to benefit from an unexpected rally. Of course, with an upper breakeven of $62.22, you'd have to be very, very wrong to profit on the call.

If You're... a Reasonably Confident, Yet Frugal, Bear

Most seasoned options traders know that scheduled events, like earnings, can push option premiums higher... and if you're the kind of penny-pinching bean-counter who refuses to pay retail, that can be a serious turn-off. However, if you're fairly confident that QCOM's trend lower will continue, you can lower the cost of entry on a long put position by turning it into a bear put spread. By selling a cheaper put against your purchased put, you've shaved some coin off your cost of entry, as well as your breakeven point and maximum potential loss. On the flip side, if the stock takes a major nosedive beneath the sold strike, you could end up ruing the day you didn't just buy a put outright.

For example, Schaeffer's Senior Equity Analyst Joe Bell proposes a July 55/July 52.50 put spread. To buy the July 55 put and sell the July 52.50 put, you'd shell out a net debit of $1.00. The max profit on a move down to $52.50 is $1.50, for a tidy profit of 150% on the trade. This strategy works "for those who want to buy at-the-money options, but still get performance anxiety ahead of big events," says Bell.

Or, you could try your hand at the out-of-the-money July 52.50/July 50 put spread, which would currently run you $0.56. On a move down to $50, you'd stand to rake in a profit of $1.94, or 346%. While the potential reward is greater, it requires a more aggressive move by the stock: "You lose all your money if QCOM doesn't get below $52.50," warns Bell.

If You're... a Glutton for Punishment

So you're now armed and ready with three option strategies to play a bearish idea on QCOM, having thoroughly addressed your individual earnings-related anxieties. But before we wrap this up, we should probably discuss what not to do -- specifically, sell premium.

"I would avoid selling premium ahead of a known event like earnings," says Schaeffer's Senior Technical Strategist Ryan Detrick. "You can really get burned when you sell premium like that, because you could have a big move against you. When you're buying options, you know how much you could lose and you accept that. But if you're selling options, things can get ugly fast if they go against you."

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