Cisco is preparing itself for a major correction after increased PUT open interest in the option chain.

After the stock has yielded very good returns for the investors of Cisco Systems, Inc. throughout the 3rd quarter of 2024, it is bound to correct its trajectory from here. Let us look in more detail at why we make a case for bearishness.

Date: Oct 5, 2024

Market Focus: Equities & Options

Time Horizon: 14-day swing

Distribution Time: Post-Market

Market Overview

• The recent conflict in the Middle East has caused some concern and led to a sell-off in the stock market, despite the S&P 500 SPX reaching new all-time highs. The benchmark index has held above its support level at 5,670, indicating only a minor correction so far. There is resistance at the recent highs, near 5,760. The PCR (put-call ratios) are giving a solid buy signal after briefly edging upward the previous week. Market breadth has been positive enough to maintain buy signals, but another day of negative breadth could push them into sell territory, requiring a two-day confirmation of any new signal. Cumulative volume breadth (CVB) has been strong, setting new all-time highs, and new highs continue to dominate new lows on the NYSE, remaining bullish for stocks.

  
  

  VIX had been giving mixed signals, but the trend of the VIX sell signal remains in place. The spike's peak buy signal of Sept. 5 was stopped out, but a potential new signal could occur if VIX closes at least 3 points below its recent highest price of 20.73. Overall, the market remains bullish as long as the S&P 500 stays above 5,670. A new buy signal will be generated if VIX closes at least three points below the highest price it has reached from Oct. 1 onward. Adjust the numbers accordingly if VIX registers a higher price before reaching a peak. The Dow Jones Industrial Average reached a record high, and Treasury yields rose on Friday after official data revealed that the economy added more jobs than expected in September. Financials and consumer discretionary sectors led the gains, while real estate and utilities closed lower.

  
  

  In economic news, the Bureau of Labor Statistics reported that total nonfarm payrolls in the US increased by 254,000 last month, surpassing the projected increase of 150,000. The unemployment rate also declined to 4.1% from August's 4.2%, which was in line with market expectations for September. The Federal Reserve had previously reduced its benchmark lending rate by 50 basis points to a range of 4.75% to 5%. However, the latest jobs report makes another 50-basis-point reduction unlikely. Instead, the Fed is expected to deliver 25-basis-point cuts in both November and December. The probability of the Federal Open Market Committee lowering interest rates by 25 basis points next month surged to 98% on Friday from 68% on Thursday, while the likelihood of a 50-basis-point cut decreased to zero from 32%, according to the CME FedWatch tool.

  
  

  The US two-year yield increased by 21.4 basis points to 3.93%, and the 10-year rate rose by 11.9 basis points to 3.97%. The International Longshoremen's Association union ended its strike across the East and Gulf Coast ports after reaching a tentative agreement on wages with the United States Maritime Alliance. The parties agreed to extend their contract through Jan. 15. - US Port Strikes have been halted with some ease on the economy. West Texas Intermediate crude oil rose by 1.3% to $74.63 a barrel, leading to a weekly gain of more than 9% by 4:45 pm ET. Gold fell by 0.3% to $2,671.10 per troy ounce, and silver dropped by 0.1% to $32.45 per ounce.

  
  

  In geopolitical news, Iran carried out a missile attack on Israel in retaliation for the killing of Hezbollah chief Hassan Nasrallah and an Iranian commander in Lebanon, and the US would support Israel striking Iranian oil facilities as per President Joe Biden - no sign of de-escalation for now and markets may be choppy for some period of time. Depending on the scale of such a response, it could potentially have a significant impact on oil markets. This is because it could lead to a disruption in Persian Gulf oil and liquefied natural gas flows through the Strait of Hormuz.

  
  

  Just on a side note on what's happening in the real estate sector - Homebuilders D.R. Horton, Lennar, and PulteGroup were down between 2% and 3% each, which contributed a quick return of about 42% in 1 day for our other position in XLRE - Real Estate Select Sector Fund ETF. Check our performance sheet for more information.

Technical Analysis

• Major Support/Resistance Levels for Stock Cisco Systems Inc.:

  • Support: 151, 148, 142.50

  • Resistance: 176, 183, 192

• Indicators:

  
  

  • MACD (Moving Average Convergence Divergence) signals sell

  • Bearish divergence on both daily and 4-hour charts between the price and MACD already manifested a few days ago and will continue forward into the next days, unless a conflict occurs.

  • Fibonacci extension levels are drawn to point out key levels for exit - mainly at 50% level at 51.51 price point making for a case for exit.

  • Volume Profile - good and gains momentum

  • Has strong resistance on weekly time frame where the stock has reversed and starting to correct its trajectory for the next few weeks. upon

  • Slight conflict from the moving averages that appear to get stacked together upwards indicating the start of a major trend. It may manifest and is in line with our tech sector predictions being higher along with the rest of the stock market going into Q4 of 2024.

  • Increasing open interest for the monthlies for Cisco PUTs for October and November.

Chart

Trade Rationale

Derivatives

Asset class: Options

Trade Type: Bear Call Spread

Sell CSCO Oct18 52 Call for a credit Buy CSCO Oct18 52.5 Call for a debit

Net credit received -$0.27/ contract (averaged over two trades)

Probability 36%

Return/Risk 1.4

Margin/max loss $0.23 /contract

Time left 13 days

There is a channel formation on Cisco for the 4-hour chart which also prompts a sideways correction downwards as you can see below. Given this with the additional technical bearishness mentioned above should be a good pinning factor for the stock at least for the near term.

This is a great position for us to capture the theta decay which is accelerated naturally in the last month nearing the expiry. These options expire on October 18, 2024 - therefore, even a slightest drop from here will yield us profits faster to the north of 50-60% of the credit received. We intend to exit the position around these levels and as a subscriber, you will receive an alert when we do so.

Strategy

• Catalysts: Dividends were exercised recently, and stock may correct with some profit booking here at these levels.

• Risk Factors: Nothing major.

• Correlation: Not applicable.

• Portfolio Exposure: This trade adds a negative exposure to the tech sector weightage and is acting as a hedge should things go wrong due to the Middle Eastern tensions where markets may tank giving us some protection from this position.

• Maximum Risk: 5% of the total portfolio capital. No deviation!

• Hedging Strategy (if applicable): NA.

  
  

Economic Events

Thursday and Friday: Inflation numbers CPI & PPI

• Impact: We may exit even before these days and we don't see a perceived impact from these numbers unless they distort the entire story for the Fed - which is unlikely.

Summary

We will exit on-demand as always with profits. The major exit level is at the Fibonacci 50% extension level drawn for the price at 51.51 - but we may exit even earlier around 52-51.5 in profits. On the upside, one may consider closing the position if Cisco surges above the 53.80.

Closing Notes

This trade is valid only as long as the price doesn't move 3% - typically for a day or two. Don't consider the trade if the stock has moved beyond 53.30 or don't accept less than $15 /contract credit for the option spread position. You may wish to take it, but the risk to reward isn't so favorable.