A 'strangle' options trade on a top cybersecurity stock reporting after the bell

Published Mon, May 20 202410:29 AM EDT

Cybersecurity stock Palo Alto Networks (PANW) will be reporting Monday after the close. Here are some things to think about ahead of that announcement, and a potential way to play it using options. The following table includes ten stocks reporting earnings this week where the options market is implying moves of 7% or greater. Highlighted in green are stocks I like, in yellow are those I am more cautious about. Palo Alto Networks was hard hit after they reported earnings on February 20th. The stock fell more than 28% immediately following that release, the company's worst one-day post-earnings decline in over a decade. PANW YTD mountain Palo Alto Networks, YTD Palo Alto Networks is a global network security solutions provider. The good news is that the company reported nearly 20% sales growth and greater than 80% gross margins for their most recently reported quarter. Secular tailwinds for cybersecurity remain as the number and sophistication of cyber-attacks continue to grow. The bad news is that the growth rate slowed for the third straight quarter, and the concern is that gross margins may fall for the quarter that ended April 30th, due to higher discounting. The notion of discounting in Palo Alto's context relates to what the company described as "spending fatigue." According to CEO Nikesh Arora, this is because while budgets have been rising at double digits annually, security breaches continue to rise too, so customers are struggling with the return on investment of their cybersecurity budgets. Another key area investors are focusing on will be spending shifts to the cloud. While this represents a huge opportunity, the company is competing with CrowdStrike and Zscaler which are pure crowd plays. Palo Alto has recovered roughly half the decline the stock suffered following its earnings release last quarter. Since April 5, the stock has nearly doubled the returns of Crowdstrike. Meanwhile, Zscaler has fallen 2% over the same period. While I find that relative strength supportive, I suspect PANW will struggle to regain the prior highs from earlier this year, even if the results are good. The trade The last earnings disappointment created resistance at higher levels as some holders may be inclined to sell if they can recover some or most of their recent losses. Palo Alto's valuation, with an expected free-cash-flow yield of 3.2% over the next 12 months and a topline growth rate north of 15%, is comparable to a company like Amazon. Justifiable, but it is a bit higher than the company's historical valuation multiples. Two-year historic multiples would price the stock somewhere between $270 and $290/share, so a reversion to a mean multiple could drop the stock somewhere in that ballpark. Consequently, I'm inclined to play a range-bound thesis ; selling a near-dated May 24th weekly $285/$350 strangle (selling the $285 puts and $350 calls), hedged by purchasing a longer-dated strangle of approximately the same strikes, specifically the September $280/$350 strangle. Note that there are no September $285 puts listed, or else I would likely have chosen those instead. Sell May 24 $285 put Sell May 24 $350 call Buy Sep. 20 $280 put Buy Sep. 20 $350 call Some premium will come out of the longer-dated strangle post-earnings, but a decent amount of that premium should be preserved because it also captures the company's subsequent earnings release in August. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL'S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.