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Spread Trader Expects a Post-Earnings Dip for Computer Sciences Corp.

Breaking down a bear put spread on CSC

by 2/7/2012 9:25 AM
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Computer Sciences Corporation (CSC - 27.45) is set to take the earnings stage before the opening bell tomorrow. According to Thomson Reuters, the firm has surpassed Wall Street's bottom-line estimates in three of the past four quarters. Nevertheless, it looks like one options speculator is bracing for a post-earnings drop, but is hedging his bets just to be safe.

During the course of yesterday's session, symmetrical blocks of several hundred puts traded at the March 25 and March 27.50 strikes. What's more, put open interest swelled at both strikes overnight, confirming the initiation of new positions. However, the 27.50-strike puts traded at the ask price of $2.15, suggesting they were bought, while the 25-strike puts crossed at the bid price of $1.05, implying they were likely sold. In other words, the strategist constructed a bear put spread on CSC for a net debit of $1.10 per pair of contracts.

By purchasing the 27.50-strike puts, the trader is expecting the shares of CSC to retreat in the short term. However, to limit the cost of entry -- which represents the maximum risk -- of the bearish trade, the investor sacrificed potential reward by selling the lower-strike puts. Plus, he trimmed his breakeven rail.

Now, he needs the shares of CSC to breach the $26.40 level (bought put strike minus net debit) in order to profit on the play. Had he simply bought the 27.50-strike puts, he'd need the shares to breach the $25.35 level (strike minus premium paid). On the flip side, the sold puts cap his maximum risk at $1.40 (difference between strikes minus net debit), no matter how far CSC sinks beneath the $25 level. Had he only bought the at-the-money puts, his profit would increase with each step south of breakeven.

Ahead of the bell, CSC is pointed 1.6% lower. From a longer-term perspective, the equity has added 15.8% in 2012, and finished last week north of both its 10-week and 20-week trendlines for just the third time since late April.


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