Cisco Call Option Buyers Look to Make Old Things New

Cisco Unusual Option Activity Report

I brought up Cisco Systems, Inc (NASDAQ: CSCO) during my daily session on the TheoTrade llive chat today. One of the replies from someone watching was that the company isn’t relevant anymore. Believe me, I understand the desire to look beyond the old stodgy companies that provide little to no growth top line growth. However, can a company that generated $48 billion in revenue in the trailing twelve months (TTM) be irrelevant?

This is where option activity can get you thinking about companies a little differently. It’s a little like someone showing interest in something that you’ve long forgotten. Suddenly it becomes new. That’s what happens when you see large option activity, you immediately begin to weigh the merits of the activity.

Cisco Option Activity

 As of this writing, Cisco has total option volume that is over four times the average. Most of the activity is on the call option side that is a sizzling 5.1 times the average and a put-to-call ratio of 0.156. The call option trades that are being made have seen 56% get filled at the ask price. That shows a strong bullish directional bias. Here’s a breakdown of the significant activity:

  • 17,000 24 DEC 20 $46 calls mostly BOT @ $0.19 to $0.33

With only one-week to expiration, these short-dated options are pointing to near-term upside in CSCO. The breakeven of the trade is near $46.33.

Cisco Fundamentals

While the option activity is pointing to the near-term potential, it doesn’t fully describe what type of opportunity is in CSCO.

Historical three-year growth statistics, it shows that CSCO has grow its revenue by 6.8% and EPS by 11.6% per year. That number pales in comparison to some of it’s more growth-oriented competitors.

Looking at analyst estimates shows a 4% revenue growth for 2022 and 1.5% revenue growth for 2023. Its EPS growth rate is 4.86%.

The fact that CSCO isn’t showing higher numbers is a reflection of its position in its industry and a big reason why it pays a dividend. This is the mistake that many investors make, they compare companies that are of a different fundamental stock type.

Cisco Dividends

When you begin to analyze Cisco as an income stock, things begin to change. Currently the company pays a forward annual dividend yield of 3.21%. That nearly double the S&P 500 average and over triple the 10-year U.S. Treasury note yield.

Here are a couple of things to consider when analyzing dividend-paying companies. The first is whether the company generates free cash flow in excess of the dividends paid. The second is whether the company pays a relatively high yield.

Free cash flow takes the operating cash flow of the company and subtracts investments in property, plant and equipment (PPE). The cash represents the amount that can be retained as earnings, paid out as dividends or to buy back stock. Cisco has generated $15.2 billion in free cash flow in the TTM compared to only $6.05 billion paid in dividends. That is a substantial margin and shows there is room to continue to raise the dividend.

The current 5-year average dividend yield is 3.03%. That means that the current yield is higher than the 5-year average. This comparison also gives some perspective on the stock’s valuation.

As you put these two considerations together along with the companies track record of paying dividends, stable earnings and revenue growth and relatively high dividend, it changes how you may look at the company.

Cisco Technicals

The chart of Cisco shown below is a weekly chart spanning the 2019 sell-off through today. The stock found support in October and held its March 2020 low. The initial rally in the price that ended on November 9 provides a “seed wave” for the current trend.

With the breakout in the price above $33, the 261.8% projection level is opened up near $49. That level also aligns with the 61.8% Fib level of the previous long-term downtrend. That level certainly corresponds with the potential indicated by the option activity. However, a breakout above that level opens up the 423% projection near the 2019 high near $58. That’s nearly 30% higher than its current level.

Conclusion

More volatile stocks have the ability to move 30% much more easily. However, there has to be some consideration for the amount of risk it takes to realize that return. With the S&P 500 testing all-time highs and VIX measures starting to signal some concern of a potential sell-off in the next months or so, looking at lower volatility, dividend stocks isn’t a bad middle ground.

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