Sunday, January 19, 2014

First trade of 2014

The market seems to be unsure what it wants to do and most of my holdings currently do not provide me with the opportunity for a compelling buy. Not that I have lost confidence in my holdings, but just that given all the metrics that I watch, none of them are yet at a point where I can pull the trigger to add more to my positions. It doesn't help that the market has run up so much without a breather.

My gut feeling tells me that the market wants to correct but the bulls are reluctant to let it go. However my prediction is that things will stall after the earnings season into April. Given the first set of earnings, things are not on fire on the long side and the earnings were only lukewarm at best. So there should be no reason for another leg of rally as far as I can tell. So I plan to wait for a stall/pull back before adding more to some of the positions I would like to add to.

In the mean time what do I do? Well there is this stock I have been watching rally close to 50% in less than 5 days that has my fingers itching. The company is FireEye and it is the latest hot startup to go IPO last year. The past 6-12 months has been a great year for web security companies and I have to say that PANW and FEYE has made full use of this timing to go IPO.

While I do not question there long term viability given the great expanse of the networks that need to be protected, I am getting a little wary of the valuations on both these companies. More so on FEYE than on PANW.

Some facts on FEYE

1. At current stock price the market stands at 8.8 billion
2. The company has a revenue of 150 million (giving it a Price to sales of 60+ while even PANW is at 10+)
3. Even with the latest acquisition and the best of analyst surveys the next years revenue is at 450 million (Which gives it a 21.6 times revenue valuation)
4. They are expected to have negative earning in the next year too.
5. Operating margins are currently at a eye popping -90%

Given it is a new IPO the numbers are hard to parse, so I am just going with the revenue guidance and to trade at 20 times the most bullish revenue guidance seems a little too much even for FEYE when PANW is at 10 seems excessive.

So for lack of activity in the market I decided to do a trade on FEYE. Following is the trade

1 70$ put option expiring on Feb22 bought at 5$

The trade comes with two assumptions

1. The Feb 11 earnings report will meet analysts expectations of revenue guidance
2. The valuation will then come closer to PANW which has been in the market longer

So where is my trade at? At 5$ on the option my real trade starts at 65$. So at 65$ we are talking about a 7.7 Billion market cap at 19.8 time revenue. So assuming the bloom comes off the rose on Feb 11 and yet the market likes the premium of FEYE over PANW, I expect the market to take FEYE down to 16-18 times revenue which is 60$ a share which should give me a 100% return on my investment.

Then why only one contract? Well because the market momentum for this stock seems to be too much and I have paid a little more than I would have liked for the contract. If the market rallies further I will add to this contract holding as it gets cheaper, but the reason to pull the trigger now was because I think the rally on this stock was too quick to last very long and the moment the violent upside stops, the puts will start getting costlier.

Mind you here that the more established players like Checkpoint (that makes money for the past so many quarters) trades at just less than 10 times revenue.

So that is the first trade for 2014.

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